Close-out Amount - ISDA Provision
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2002 ISDA Master Agreement
Definition of Close-out Amount in a Nutshell™ Use at your own risk, campers!
Full text of Definition of Close-out Amount
Related agreements and comparisons
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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.
So the dirty secret is that there isn’t a “Close-out Amount” as such under a 1992 ISDA (or the 1987 ISDA) but, in places on this wiki, we’ll refer to one anyway, because it is better, more elegant, more stylish prose than
“... the amount determined following early termination of a Terminated Transaction using Market Quotation or Loss (as the case may be) and the Second Method, seeing as no-one in their right mind would agree to the First Method, under the 1992 ISDA”.
In the context of a 1992 ISDA that is what we mean by “Close-out Amount”.
Summary
In the “good old days” of the 1992 ISDA, you valued Terminated Transactions according to Market Quotation or Loss and those un-intuitive and — well,in the case of the first, 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.
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.
On the difference between an “Early Termination Amount” and a “Close-out Amount”
Regrettably, the 1992 ISDA features neither an Early Termination Amount nor a Close-out Amount. 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 Transaction 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 after the close-out process. (See Section 6(e)(i) for more on that).
General discussion
For a step-by-step guide to closing out an ISDA Master Agreement see Section 6(a).
The 2002 ISDA does away with specific references to Market Quotation and “Reference Market-makers” but they are still, somewhat, germane thanks to the references to “quotations (either firm or indicative) for replacement transactions supplied by one or more third parties”.
The quaint notion that a dealer poll would, at the point when needed, actually do anything was laid to rest in the 2023 case of Lehman Brothers International (Europe) v AG Financial Products, Inc. which involved the closeout and valuation of a 1992 ISDA following Lehman’s collapse.
This case is an object less on for many unacknowledged facts about derivatives trading — such as that cases involving seemingly tried and tested aspects of close-out methodology get litigated at all, let alone that they take 15 years to get to judgment — but the standout point is the forlorn pointlessness of convening dealer polls.
From Crane J’s factual summary:
In accordance with its responsibilities under the ISDA Master Agreement, following its declaration of an event of default, Assured engaged the assistance of Henderson Global Investors, Ltd. (Henderson), to conduct an auction so that it could satisfy the ISDA Market Quotation process. Henderson contacted 11 potential bidders in advance of the auction that took place on September 16, 2009. Not one bid was received.[1]
LBIE did manage to get some indicative bids that were, expert witnesses thought “indicative market data of where these transactions, these underlyings would be trading at that stage on termination date”. But not one of them was prepared to make a binding offer, and the most fulsome indicative bid was disclaimed up the wazoo:
“This is not investment advice of any kind and we do not purport any degree of accuracy in these levels.”
Useless, you would think, as an input in determining a fair market level. Indeed, internal LBIE emails — kids, if you learn one sodding lesson from the history of financial market disaster let it be “don’t put your darkest thoughts in emails to your buddies” — suggested they only wanted indicative bids to encourage other banks (many may have had similar trades on their books as LBIE), to make any bid, so that LBIE could then argue there was a market price:
“any color is good color to us and [JP Morgan employee] is lobbying for [JP Morgan’s US trading team] to at least put a number on it even if it is zero”.
Crane J notes, somewhat drily: “This raises the concern that LBIE’s goal, with respect to the indicative bids, was to make these trades seem as worthless as possible to then be able to collect the most from Assured in a lawsuit.”
So here are some things to bear in mind before reaching for a dealer poll to unblock a negotiation that is stuck on valuation:
Firstly, at the point you are likely to be arguing about it, everyone’s hair — yours, the counterparty’s and the rest of the market’s — hair will be on fire. Prices will be yoyoing around and most people will be focussed on their own book and won’t care about yours. Imagine your reference dealer is sitting on one of those mechanical bucking broncos. At the moment you ask for a firm bid on your portfolio — that, by the way, you don’t intend to hit — someone switched the bronco on full.
Secondly, since it has nothing to gain from providing a price — you want “price discovery”, not an actual trade, remember — no dealer in its right mind will give you one. Best case scenario it is distracted from managing its own book while bronco machine is on max. Less edifying ones are that it could get called as a witness in the litigation that is bound to follow or, God forbid, joined as a defendant in it. All your incautious bloomies are suddenly discoverable before an unsympathetic court.
See also
- Section 6(e) of the ISDA Master Agreement
- Early Termination Amount
- Barclays v Unicredit on what amounts to acting in a “commercially reasonable manner”
1992 equivalents
References
- ↑ Emphasis in original.