Cross acceleration - ISDA Provision

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2002 ISDA Master Agreement

A Jolly Contrarian owner’s manual™

Cross acceleration in a Nutshell

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Original text:

Section 5(a)(vi) is amended by deleting “, or becoming capable at such time of being declared,” from subsection (1).

By way of reminder:

5(a)(vi) Cross-Default. If “Cross-Default” is specified in the Schedule as applying to the party, the occurrence or existence of:―
(1) a default, event of default or other similar condition or event (however described) in respect of such party, any Credit Support Provider of such party or any applicable Specified Entity of such party under one or more agreements or instruments relating to Specified Indebtedness of any of them (individually or collectively) where the aggregate principal amount of such agreements or instruments, either alone or together with the amount, if any, referred to in clause (2) below, is not less than the applicable Threshold Amount (as specified in the Schedule) which has resulted in such Specified Indebtedness becoming, or becoming capable at such time of being declared, due and payable under such agreements or instruments before it would otherwise have been due and payable; or
(2) a default by such party, such Credit Support Provider or such Specified Entity (individually or collectively) in making one or more payments under such agreements or instruments on the due date for payment (after giving effect to any applicable notice requirement or grace period) in an aggregate amount, either alone or together with the amount, if any, referred to in clause (1) above, of not less than the applicable Threshold Amount;
The Varieties of ISDA Experience
Subject 2002 (wikitext) 1992 (wikitext) 1987 (wikitext)
Preamble Pre Pre Pre
Interpretation 1 1 1
Obligns/Payment 2 2 2
Representations 3 3 3
Agreements 4 4 4
EODs & Term Events 5

Events of Default
FTPDBreachCSDMisrepDUSTCross DefaultBankruptcyMWA
Termination Events
IllegalityTax EventTEUMCEUMATE

5

Events of Default
FTPDBreachCSDMisrepDUSTCross DefaultBankruptcyMWA
Termination Events
IllegalityTax EventTEUMCEUMATE

5

Events of Default
FTPDBreachCSDMisrepDUSTCross DefaultBankruptcyMWA
Termination Events
IllegalityFMTax EventTEUMCEUMATE

Early Termination 6

Early Termination
ET right on EODET right on TEEffect of DesignationCalculations

6

Early Termination
ET right on EODET right on TEEffect of DesignationCalculationsSet-off

6

Early Termination
ET right on EODET right on TEEffect of DesignationCalculationsSet-off

Transfer 7 7 7
Contractual Currency 8 8 8
Miscellaneous 9 9 9
Offices; Multibranch Parties 10 10 10
Expenses 11 11 11
Notices 12 12 12
Governing Law 13 13 13
Definitions 14 14 14
Schedule Schedule Schedule Schedule
Termination Provisions Part 1 Part 1 Part 1
Tax Representations Part 2 Part 2 Part 2
Documents for Delivery Part 3 Part 3 Part 3
Miscellaneous Part 4 Part 4 Part 4
Other Provisions Part 5 Part 5 Part 5

Resources and Navigation

Index: Click to expand:

Overview

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Well, it doesn’t, as such, appear in the ISDA Master Agreement at all, but you could always have a look to see how different Cross Default is.

Summary

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Cross acceleration” is not an actual ISDA Event of Default, but it is what happens to an actual ISDA Event of Default — namely, the much-negotiated, seldom-used Section 5(a)(vi), Cross Default, if you can persuade your credit department to water it down to something sensible.

Cross acceleration: what is it?

Cross acceleration is like cross default, but it only arises when the non-defaulting party has actually accelerated the contract. Therefore it is a higher threshold and a less sensitive trigger, and avoids that weird scenario when the actual creditor has not itself triggered its default rights, but an opportunistic third party holder of a cross default right can jump in and close out anyway (therefore making the benign creditor less likely itself to show leniency for the original default, it being a nasty, brutish and short old world out there).

How to change Cross Default to cross acceleration

You can amend Cross Default to Cross Acceleration by adding the language in the panel: Seems so easy, doesn’t it?

Cross Default is triggered by two kinds of default:

  1. General default: a general event of default of any kind at any time during the tenor of any Specified Indebtedness — this could be anything: the borrower’s bankruptcy, a breach of its reps and warranties, a non-payment of interest, any repudiatory breach of the contract of indebtedness, really; or
  2. Repayment default: a borrower’s failure to fulfil, in full, final repayment of the debt itself when due.

Why distinguish between them, seeing as both are cataclysmic?

There is an answer, but it is fussy, word-smithy stuff: because a general default entitles the lender to accelerate the debt requiring the borrower to repay it at once, before its scheduled maturity date; a repayment default, logically, falls on that scheduled maturity date, and so can’t be “accelerated” as such. There is nothing to “accelerate”: our destination, the repayment date, is already here.

Therefore to convert a cross default to a cross acceleration, you only need to require general defaults to have been accelerated. Repayment defaults can’t be accelerated.

Cross acceleration also avoids the need to muck around waiting for grace periods to expire, granting indulgences for administrative and operational error and all that dreck: if the counterparty has actually accelerated the loan, the grace periods and operational errors no longer matter. It is too late. The game is up.

Now, to be sure, legal eagles might start hopping up and down, flapping their wings and squawking restively at this point.

“But,” they will say, “what about grace periods and operational errors on that final payment? We must be allowed those before you can close out!”

The short answer is that ordinary grace periods are factored in — the event isn’t triggered until they have all expired. As for affordances that don’t quite count as grace periods (for example, concessions allowing a borrower to provide evidence of operational error, giving it some more time to pay) — well, on a fair, large and liberal view these count as grace periods anyway.

Is “downgrading” to cross acceleration wise?

There are two schools of thought:
Yes: The sensible, pragmatic, wise, noble, fearless and brave one you will find in these pages: “Yes. Cross default is misplaced in a modern daily-collateralised ISDA. Anything you can do either to restrict its scope, or simply to avoid being dragged into a tedious argument about its scope, is worth doing.”
No: The learned one, from the learned author of that terrible FT book about derivatives: “All other things being equal, no. One should only soften cross default reluctantly. Because other counterparts might not be so weak.”

A brief critique of the FT Book about derivatives

This, in our view, rather mischaracterises what is going on.

“With cross acceleration the innocent third party actually has to start proceedings against the defaulting counterparty before you can trigger your transaction termination rights ...”

But it doesn’t have to sue your counterparty; just call its debt in.

“The downgrading [of cross-default to cross acceleration] therefore affects the timing of your right to terminate, It is no longer automatic but deferred.”

We don’t know what the learned author means by “automatic”: either way, the termination right is optional, not automatic, but in either case, it is contingent on a different independent event: in one case, the more nebulous “default”; in the other, a lender’s quite hard-edged acceleration following the default.

“If the third party is your counterparty’s main relationship bank it may take some time to review its position...”

Indeed it may, and probably will. But while it is doing that it is not accelerating its claim against your counterparty. It is granting its customer, and your counterparty, an indulgence. Your position is, therefore, not worsened in the meantime.

“... and may propose a compromise which does not suit you.”

You, bear in mind, are the owner of a fully collateralised ISDA Master Agreement which the counterparty has, in the meantime, continued faithfully to perform. If one of your co-creditors has granted an indulgence on outstanding indebtedness — even in return for some other surety or compromise — which avoid that debt being accelerated in full, how can that by itself make your position worse?

“I believe such downgrade requests should only be considered favourably if specific foreseeable circumstances justify them [...] or if your counterparty gives written confirmation that cross acceleration applies to all its agreements and will do so in the future. This is because if even one counterparty has Cross Default it would be in pole position to trigger its termination rights.”

On this last point, the learned author is, technically, correct: you are marginally worse off if you have conceded cross acceleration and other swap counterparties have not. They can beat you, and your counterparty’s main relationship bank, to the punch, assuming they are cowboys who view a relationship contract like an ISDA Master Agreement as something that it should be a race to close out. Brokers that the JC knows don’t tend to think that way. They have compliance officers who will quail at the thought of not treating their customers fairly. In any case, the fact that this could happen just illustrates how stupid the concept of cross-default is. Especially in our enlightened age of zero-threshold, daily margined non-exotic swap contracts. Especially given the extreme conceptual difficulty of even gathering enough information to work out whether you even can exercise your stupid cross default right.

Just how a third party would ever be able to assess the value of defaulted Specified Indebtedness has never been explained to this old goat.

So this is angel-on-the-head-of-a-pin stuff indeed.

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  • JC’s “nutshell” summary of the clause
  • Background reading and long-form essays

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See also

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References