Cross Default - GMSLA Provision
There is no cross default in a securities financing transaction
There’s no need for cross default in any master trading agreement, actually — this is the JC’s considered view, about which you can read at length elsewhere — but the 2010 GMSLA and Global Master Repurchase Agreement are a particularly bad candidates for cross default because their transactions are by definition short term (in the case of repo) and callable at any time (in the case of stock loans) and fully collateralised, so the “mischief” cross default is designed to fix — large credit exposure under long tenor transactions with few regular cash-flows — does not exist.
Cross default is a banking concept. It is designed to protect lenders who have unsecured credit exposure to borrowers under fixed rate loans where the only payments will be period interest payments, which might be only quarterly, half-yearly or even yearly. For your average credit officer, a year between scheduled payments is a long time between drinks. If she knows the borrower has defaulted in a big way to some other lender — some random — she will not want to wait nine months to for a failure to pay on her own facility. She will want to hit DEFCON 5 straight away; ideally, even before that other random lender has.
Hence, she will seek a cross default right: If random guy can pull you down, I can pull you down.
There’s no need to put one in. Even if you are doing term loans.
All the talk of borrowers and lenders in securities financing transactions makes a fellow giddy. But remember: SFTs are not contracts of indebtedness. Even though they’re called “Loans”, they are not actually, you know, loans. Lenders aren’t — legally or economically —lenders. Thus, there is no cross default in any standard SFT agreements. This was not a mistake. It was deliberate. You don’t need one.
Now, there is a certain stripe of credit officer who will not be convinced of this, and will want to put one in anyway. Does it do any harm? Well yes, actually: it creates contingent liquidity issues for your own treasury department, whom credit will routinely ignore when making their credit requests. And yes, from the perspective of production waste in the negotiation process: insisting on a cross default is, par excellence, the waste of over-processing.
Yeah, but why not, just to be on the safe side?
Why not put one in for good measure? SFTRs are collateralised daily, so:
- Neither party has material exposure;
- There will usually be payments flowing each way daily as loaned Securities and Collateral values move around, creating collateral transfers; and
- Even if there aren’t, either party can recall the loans on any day
- If anything, a fully collateralised Lender, benefitting from a 5-10% haircut, is a net borrower. See Pledge GMSLA for what do about that if upsets your leverage ratio denominator.
- Okay, okay, a borrower under an agent lending transaction may have a significant exposure across all lenders due to aggregated collateral haircuts, but that is by definition diversified risk, and the borrower can generally break term transactions.
- Unless they are term transactions, but even there, the terms tend to be short — ninety days is a maximum — and see above re usual daily collateral flows.