Change in Law - Equity Derivatives Provision

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2002 ISDA Equity Derivatives Definitions
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Resources About the Equity Derivatives Definitions | (full wikitext) | (nutshell wikitext)
Hot topics Synthetic Prime Brokerage Anatomy | The Triple Cocktail | Cancellation and Payment | Calculation Agent
TOC | 1 General Definitions | 2 Option Transactions | 3 Exercise of Options | 4 Forward Transactions | 5 Equity Swap Transactions | 6 Valuation | 7 Settlement | 8 Cash Settlement | 9 Physical Settlement | 10 Dividends | 11 Adjustments and Modifications | 12 Extraordinary Events · 12.8 Cancellation Amount · 12.9 Additional Disruption Events · 12.9 List of ADEs · 12.9(b) Consequences of ADEs | 13 Miscellaneous

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Section 12.9(a)(ii) in a Nutshell
Use at your own risk, campers!

12.9(a)(ii)Change in Law” means either party determines that, due to a change in law or regulation:
(X) it becomes illegal to buy, sell or hold underlying Shares or;
(Y) it becomes materially more expensive to perform the Transaction.

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Full text of Section 12.9(a)(ii)

12.9(a)(ii)Change in Law” means that, on or after the Trade Date of any Transaction:
(A) due to the adoption of or any change in any applicable law or regulation (including, without limitation, any tax law), or
(B) due to the promulgation of or any change in the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law or regulation (including any action taken by a taxing authority),
a party to such Transaction determines in good faith that:
(X) it has become illegal to hold, acquire or dispose of Shares relating to such Transaction, or
(Y) it will incur a materially increased cost in performing its obligations under such Transaction (including, without limitation, due to any increase in tax liability, decrease in tax benefit or other adverse effect on its tax position);

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Section 12.9(a): The actual Additional Disruption Events

12.9(a)(i) Additional Disruption Event
12.9(a)(ii) Change in Law
12.9(a)(iii) Failure to Deliver
12.9(a)(iv) Insolvency Filing
12.9(a)(v) Hedging Disruption
12.9(a)(vi) Increased Cost of Hedging
12.9(a)(vii) Loss of Stock Borrow
12.9(a)(viii) Increased Cost of Stock Borrow

Change in Law is part of the great triple cocktail of protections against nasty things happening on your hedge. The consequences of a Change in Law (or an Insolvency Filing are set out in 12.9(b)(i).


“It has become illegal”

For those inclined to look even gift horses in the mouth, this provision may appear to leave some things unsaid.

Some other way of holding Shares

What if it has become illegal to hold Shares the way the Hedging Party is holding them, but it remains legal to hold them some other way? For example, if Shares needed to be listed on a certain Exchange, or cleared across a certain clearinghouse? At first blush this seems fanciful but before you laugh don’t forget this was one of the potential consequences of Brexit — and for the Swissies — when the EU share trading obligation row blew up in 2019.

Even leaving aside the direction that one must act in good faith in arriving at one’s conclusion, it is hard to see how one could say it was “illegal to hold Shares” if in fact one could legally hold those Shares some other way. So this one’s a bit silly.

Other hedges, without Shares, still possible

What if one could hedge via futures, derivatives, GDRs or some other instrument without significant extra cost or inconvenience? Would that still count as a Change in Law, just because you couldn't hedge with actual Shares?

But is “hold, acquire or dispose of Shares relating to such Transaction” too narrow when a Hedging Party may be able to hedge some other way (i.e., via futures, swaps, depositary receipts and so on)?

Well, as fussy as it may seem, it is hard to fault in its basic logic. The scope entertained by ISDA’s crack drafting squad™ does seem a shade narrow, talking as it does only of Shares and not other instruments by which one could hedge an exposure. Not even our old friend the good faith rider can win the day here, since the clause only talks about acquiring, holding or disposing of Shares themselves. On the other hand, if a jurisdiction has declared the very act of holding a physical Share illegal, it is hard to see anyone in the jurisdiction offering a swap on it, so this may be more of a theoretical than a practical objection, especially where it is a synthetic equity swap where the hedging party has no incentive not to accommodate its client if it can source an alternative legal, somehow-derivative, hedge.

You may be inclined, therefore, gracefully to concede. We don’t think you’ll have to do this often, this is a bit of an aficionado’s point. So, knee-slide and jet wings to the whoever the negotiator was who thought of it.

Amended Change In Law” for closed markets

The Standard 2002 ISDA Equity Derivatives Definitions definition of Change in Law is often amended as follows (for example in the 2007 European Master Equity Derivatives Confirmation Agreement:

Section 12.9(a)(ii) of the Equity Definitions is replaced in its entirety by the words:

Change in Law” means that, on or after the Trade Date of any Transaction:

(A) due to the adoption of or any change in any applicable law or regulation (including, without limitation, any tax law), or
(B) due to the promulgation of or any change in the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law or regulation (including any action taken by a taxing authority),

the Calculation Agent determines in good faith that it has become illegal for a party to that Transaction to hold, acquire or dispose of Hedge Positions relating to such Transaction, provided that this Section 12.9(a)(ii) shall not apply if the Calculation Agent determines that such party could have taken reasonable steps to avoid such illegality.

The reason usually given is that in a closed market, it is often difficult to determine whether a party could have taken reasonable steps to avoid the Illegality.

General discussion

Shares versus Hedge Positions

Common to see references in (x) to “Shares” replaced by the slightly wider “Hedge Positions”. Not objectionable, but not massively germane either. Ok, maybe your Hedging Party is hedging with futures, or a derivative and not Shares directly. But even then, and someone else[1] therefore, is holding the Shares. Note that Hedge Positions is wide — it talks about “hedging the Transaction”, not just “the equity price risk of entering into and performing its obligations with respect to the relevant Transaction” as does, for example, Increased Cost of Hedging. So it can save you quite a lot of anal drafting.

But they can either continue to do that, and your Hedging Party can continue to hold its future or swap — in which case what’s your disruption? — or they can’t, in which case you have a more general Hedging Disruption. We don’t think it is so likely that it will somehow become illegal to hold a future or swap — one doesn’t tend to nationalise derivatives on the whole — but in these kooky political times anything is possible, I suppose.

Reasonable steps to avoid?

Uber pedants may also try to argue that there should be some obligation on the Hedging Party to take reasonable steps to avoid a change in law. This is silly, Chicken Lickenish behaviour. I mean, what are you meant to do? Lobby Congress? Remember, “Hedge Positions” is wider and more generic than “any particular hedge position that you happen to have on” at the time the law changes. If you can change your hedging strategy, you are not subject to a Change in Law. So resist this drafting, but don’t die in a ditch about it.

For details freaks

Omission of “Prong Y

The industry has generally moved to omit Prong Y, though possibly errantly so — the “material increase in costs” limb of this definition — because it is largely dealt with already in “Increased Cost of Hedging”. It was introduced to capture those changes in law and regulation (changes in regulatory capital calculations, for very good example), that are driven by legislation, but don’t outlaw the trade altogether, but just make it more expensive to run (either the transaction itself, or its hedge)

But, if you were splitting hairs, you might say that not all “materially increased” costs a party may incur “in performing its obligations under such Transaction” will necessarily relate to hedging — if you suffer a higher regulatory capital charge on your actual transaction with your counterparty, that would not be an Increased Cost of Hedging, so a Hedging Party (and, when it comes to it, a non-Hedging Party) should stand its ground on omitting “Prong Y”.

Those who do not have the stomach for this fight may see this expressed as: “Applicable, provided that Section 12.9(a)(ii)(Y) of the Equity Definitions does not apply.”

See also, for example, the 2007 European Master Equity Derivatives Confirmation Agreement. Yet, arguably, there’s no crossover here between Prong Y and Increased Cost of Hedging, as Prong Y only related to performance of the Transaction not the hedge.

Prong Y was also a cool band.

See also



  1. E.g., the Hedging Party’s swap counterparty, right?