Close-out Amount - ISDA Provision
2002 ISDA Master Agreement
Definition of Close-out Amount in full
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On the difference between an “Early Termination Amount” and a “Close-out Amount”
The 1992 ISDA features neither an Early Termination Amount or a Close-out Amount, which many would see as a regrettable oversight. The 2002 ISDA has both, which looks like rather an indulgence, until you realise that they do different things.
A Close-out Amount is the termination value for a single Transaction, or a related group of Transactions that a Non-Defaulting Party or Non-Affected Party calculates while closing out an 2002 ISDA, but it is not the final, overall sum due under the ISDA Master Agreement itself. Each of the determined Close-out Amounts summed with the various Unpaid Amounts to arrive at the Early Termination Amount, which is the total net sum due under the ISDA Master Agreement at the conclusion of the close-out process. (See Section 6(e)(i) for more on that).
ISDA’s crack drafting squad™ introduced the Close-out Amount into the 2002 ISDA to correct the total trainwreck of a close-out methodology set out in the 1992 ISDA. In the “good old days”, you valued Terminated Transactions were valued according to Market Quotation or Loss and those un-intuitive and — well, flat-out nutso — “First” and “Second” Methods. There is a “Settlement Amount” concept under the 1992 ISDA, but it only really relates to Market Quotation.
From the you’ll be sorry you asked file. Have a butcher’s at the nutshell version on the right. If, having read that, you’re still not really feeling sorry or resentful, the full text (below) right might get your remorse radar pinging.
Note the prominent requirement to achieve a “reasonable” (1992 ISDA) or “commercially reasonable” (2002 ISDA) result. On what that latter lovely expression means see Barclays v Unicredit. Spoiler: it’s basically good for brokers as long as they aren’t being total dicks.
There are some local variations which are worth bearing in mind:
Close-out Amount and Italian counterparties
See for more detail, here: Italian counterparties
Releationship with Early Termination Amount
For those curious about the difference between the Early Termination Amount and the Close-out Amount in the 2002 ISDA, look no further than back there, along the sentence you've just read. Go on.
Closing out an ISDA Master Agreement following an Event of Default
Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.
In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.
So, to close out following a Failure to Pay or Deliver, you will need:
1. There must be a failure to pay or deliver under Section 5(a)(i)
2. You must give notice of the failure under Section 5(a)(i)
The Non-defaulting Party must give the Defaulting Party notice of the failure. This is not a Section 6(a) notice — calm, down, we will get to that in good time — but a Section 5(a)(i) notice of failure to pay or deliver. The sainted ISDA Master Agreement does not directly prescribe the format for this notice, but Section 12 cautions that it may not be by e-mail or electronic messaging system or (if you have a 1992 ISDA, at any rate), by fax. The proper form is to have it hand-delivered by someone prepared to swear an affidavit as to when and where they delivered it to the Defaulting Party.
Since payments and deliveries are generally due at close of business on a given day, Q.E.D., a Section 5(a)(i) notice of Failure to Pay or Deliver can usually only be given after close of business on the due date.
3. You must allow the grace period under Section 5(a)(i) to expire
At this point you have a Potential Event of Default, but not an actual one.
Once your Section 5(a)(i) notice of Failure to Pay or Deliver is effective, the Defaulting Party has a “grace period” in which it may sort itself out and make the payment or delivery in question, thereby heading off a full-blown Event of Default.
The standard grace periods are set out in Section 5(a)(i). Be careful: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore, you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
Let us imagine for a moment you have indeed waited the necessary time.
4. You may now send your Section 6(a) notice designating an Early Termination Date
At the expiry of the Section 5(a)(i) grace period, you finally have a fully operational Event of Default. Now Section 6(a) allows you, by not more than 20 days’ notice to designate an Early Termination Date for all outstanding Transactions.
So, at some point in the next twenty days there will be a final reckoning and one Party will pay the other the Early Termination Amount.But we have a ways to go before we even know what that amount will be. But observe: the payment date is now locked in. Time to get your skates on and start closing out Transactions.
5. Determine Close-out Amounts
Now armed with our crystalised Failure to Pay or Deliver Event of Default and with an Early Termination Date to target, we go directly to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked.
There is a bit of a chicken licken-and-egg situation here as you can’t really work out their mark-to-market values for that date at any time before that date, unless you are able to see into the future or something. Anyway, that’s a conundrum for your trading people (and in-house metaphysicians) to deal with and it need not trouble we eagles of the law. For our purposes, the trading and risk people need to come up with Close-out Amounts for all outstanding Transactions. Once they have done that you are ready for your Section 6(e) notice.
6. Calculate and notify
The Early Termination Date is the date on which the Transactions terminate; it is the date by reference to which you calculate their termination values, not the date by you have to have valued, much less settled outstanding amounts due as a result of their termination — that would be a logical impossibility for those not imbued with the power of foresight. Here we move onto Section 6(d), under which, as soon as is practicable after the Early Termination Date, your boffins work out all the termination values for each Transaction, tot them up to arrive at the Section 6(e) amount, and send a statement to the defaulting party, specifying the Early Termination Amount payable, the bank details, and reasonable details of calculations.
7. Pay your Early Termination Amount
Your in-house metaphysicians having calculated your Close-out Amounts, and assembled all the values into an Early Termination Amount the party who owes it must pay the Early Termination Amount. With ISDA’s crack drafting squad™ yen for infinite fiddlarity, this will depend on whether the Early Termination Date follows an Event of Default or an Termination Event. If the former, the Early Termination Amount is payable at once, as soon as the 6(d) statement is deemed delivered; if a Termination Event, only two Local Business Days — I know, right — after the 6(d) statement is delivered (or, where there are two Affected Parties and both are delivering each other 6(d) statements — I know, right — after both have done so).
8. Putting that all together
Here are all the stages you must go through between becoming entitled to terminate and settlement for a Failure to Pay or Deliver:
- T: There must be a Failure to Pay or Deliver on a day, T.
- T+1: After close of business on T, the Non-defaulting Party must give the Defaulting Party a Section 5(a)(i) notice of failure to pay of deliver. The prescribed grace period must expire. The grace periods may be between 1 and 3 LBDs. There may also be carve-outs for operational failures and so on, to add to the fun.
- T+4: You must send a Section 6(a) notice designating an Early Termination Date for all outstanding Transactions. Let’s say it is 3 LBSs. You must designate an Early Termination Date within 20 days. Let’s say it is 20 days, for the hell of it
- T+24: You are “off risk” and must start calculating your Close-out Amounts for all outstanding Transactions. You must do this ass soon as reasonably practicable. Let’s say that takes another 30 days.
- T+54: having calculated all Close-out Amounts and totted them all up into a single Early Termination Amount: You send your Section 6(d) statement advising of that amount, giving bank details and supplying your workings.
- T+54: Your Early Termination Amount is due.
- Section 6(e) of the ISDA Master Agreement
- Early Termination Amount
- Market Quotation
- Barclays v Unicredit on what amounts to acting in a “commercially reasonable manner”
- I’m sorry I asked
- This is not to say it isn’t hugely over-engineered, all the same: regular readers will know that the JC would never not say that about the output of ISDA’s crack drafting squad™.
- Yes, it’s true: in ISDA’s alternative universe, e-mail and electronic messaging systems are different things.
- Spod’s note: This notice requirement is key from a cross default perspective (if you have been indelicate enough to widen the scope of your cross default to include derivatives, that is): if you don’t have it, any failure to pay under your ISDA Master Agreement, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close their ISDA Master Agreement with your Defaulting Party because of it defaulted to you, even though (a) the Defaulting Party hasn’t defaulted to them, and (b) you have decided not to take any action against the Defaulting Party yourself.
- See discussion on at Section 6(a) about the silliness of that time limit.
- By a striking oversight, not actually so named in the 1992 ISDA.
- Or their equivalents under the 1992 ISDA, of course.
- If Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.
- Or, in the 1992 ISDA’s estimable prose, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to this Section”.