Change in Law - Equity Derivatives Provision

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2002 ISDA Equity Derivatives Definitions

A Jolly Contrarian owner’s manual™

12.9(a)(ii) in a Nutshell

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12.9(a)(ii) in all its glory

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.

Premium content

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  • The JC’s famous Nutshell summary of this clause
  • “Shares” versus “Hedge Positions” when it comes to Change in Law
  • “Reasonable steps” to avoid a Change in Law — such as what? writing to your MP? Moving to Spain?
  • “Amended” Change In Law for “closed markets” — some drafting you see in master confirmations.

See also