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| {{nuts|2002 ISDA|Cross Default}} | | {{newisdamanual|5(a)(vi)}} |
| {{fullanat2|isda|5(a)(vi)|1992|5(a)(vi)|2002}}
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| {{DUST and Cross Default Comparison}}
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| ===The difference between the two formulations===
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| ====Measure of the Threshold====
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| *'''The 1992 Version''': This contemplates default ''in an aggregate '''amount''''' exceeding the {{isdaprov|Threshold Amount}} which would justify early termination of the {{isdaprov|Specified Indebtedness}} - that is to say the defaulted payment contributes to the {{isdaprov|Threshold Amount}}, not the principal amount of the Specified Indebtedness itself;
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| *'''The 2002 Version''': This contemplates an [[event of default]] under agreements whose “'''aggregate principal amount'''” is greater than the Threshold Amount: that is to say it is the ''whole principal amount'' of the agreement which is picked up, not just the amount of the payment.
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| This change, we speculate, is meant to fix a howler of a drafting lapse:
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| *It can be triggered by any [[event of default]], not just a payment default (I.e. the 1992 wording "''an event of default ... in an amount equal to...''” impliedly limits the clause to payment defaults only, since other defaults aren't "in an amount"...);
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| *It captures the whole size of the {{isdaprov|Specified Indebtedness}}, not just the value of the defaulted payment (if it even ''is'' a payment) itself.
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| For example: if you defaulted on a (relatively small) interest payment, which made the whole loan repayable, under the 1992 formulation you could only count the value of the missed interest payment to your Threshold Amount. But the risk to you ise whole size of the loan, as that is what could become repayable if the loan is accelerated.
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| It is innocuous, that is, unless you are cavalier enough to include ''derivatives or other payments which are not debt-like'' in your definition of {{isdaprov|Specified Indebtedness}}. But if you do that, you've bought yourself a wild old ride anyway.
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| In case it isn't clear, {{isdaprov|Cross Default}} is intended to cover off the unique risks associated with ''lending money to counterparties who have also borrowed heavily from other people''. If you try - as starry-eyed credit officers like to - to apply it to contractual relationships which aren't debtor/creditor in nature, it will give you gyp.
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| Don't say you weren't warned.
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| ====Aggregation of limbs (1) and (2)====
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| The 1992 version doesn't specifically provide that you can aggregate amounts calculated under each limb. Arguably that's implied - but you know what derivatives lawyers are like! DON'T IMPLY ANYTHING. IT MAKES AN IMP OUT OF L AND Y. You get the picture.
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| Rather uniquely attention-sapping drafting all round.
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| ===General===
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| ''This article is specifically about the {{isdaprov|Cross Default}} provision in the {{isdama}}. See: [[cross default]] for a general discussion of the concept.
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| Under the {{isdama}}, if the cross default applies, the occurrence with respect to a party of a payment default under, or other circumstance that could result in the early termination of, {{isdaprov|Specified Indebtedness}} above an agreed {{isdaprov|Threshold}} will give the other party the right to terminate transactions under the ISDA Master.
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| Specified Indebtedness is usually defined to any claim against a party (by any third party) for [[borrowed money]] (e.g. bank debt; [[deposits]] etc.) and the {{isdaprov|Threshold}} which triggers it is usually defined as a cash amount or a percentage of shareholder funds.
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| If the cross default applies, the terms of any {{isdaprov|Specified Indebtedness}} owed by the counterparty above the {{isdaprov|Threshold Amount}} are, in effect, indirectly incorporated into the {{isdama}}. For example, the breach of a financial covenant in a qualifying loan facility, '''even if not acted upon by the lender of that facility''' would give a swap counterparty the right to terminate transactions under the ISDA Master even though the ISDA Master itself contains no financial covenants.
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| ===Cross Aggregation===
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| The {{2002ma}} updates the {{1992ma}} cross-default provision so that if the outstanding amount under the 2 limbs of cross-default added together breach the {{isdaprov|Threshold Amount|Threshold Amount}}, then that will trigger cross default. Normally, under the {{1992ma}} , cross-default is only triggered if an amount under one or the other limbs is breached.
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| As per the above, the two limbs are:
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| *a default or similar event under financial agreements or instruments that has resulted in indebtedness becoming capable of being accelerated and terminated by a Non-defaulting Party
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| *a failure to make any payments on their due date under such agreements or instruments after notice or the expiry of a grace period.
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2002 ISDA Master Agreement
A Jolly Contrarian owner’s manual™
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| ISDA Text: 5(a)(vi)
- 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;
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Related agreements and comparisons
Resources and Navigation
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Overview
The 2002 ISDA updates the 1992 ISDA’s Cross Default so that if the combined amount outstanding under the two limbs of Cross Default exceed the Threshold Amount, then it will be an Event of Default. Normally, under the 1992 ISDA, Cross Default requires one or the other limbs to be satisfied — you can’t add them together. This was a bit of a snafu.
The two limbs are:
- a default under a financial agreement that would allow a creditor to accelerate any indebtedness that party owes it;
- a failure to pay on the due date under such agreements after the expiry of a grace period.
Summary
Cross Default is intended to cover the unique risks associated with lending money to counterparties who have also borrowed heavily from other people.
Now, if — as starry-eyed young credit officers in the thrall of the moment are apt to — you apply this thinking to contractual relationships which aren’t “term loany” in nature — that is, that don’t have long spells where one party is deeply in the hole to the other, with not so much as interest payment due for months whose failure could trigger any acceleration — it will give you trouble. We go into this more in the premium JC.
Specified Indebtedness is generally any money borrowed from any third party (e.g. bank debt; deposits, loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation. Again, more details on why in the premium section.
The Threshold Amount is a key feature of the Cross Default Event of Default in the ISDA Master Agreement. It is the level over which accumulated indebtedness defaults comprise an Event of Default. It is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — schoolboy error hazard alert — be careful to say whether it is the greater or lesser of the two.
Because of the snowball effect that a cross default clause can have on a party’s insolvency it should be big: like, life-threateningly big — because the consequences of triggering a Cross Default are dire, and it may create its own chain reaction beyond the ISDA itself. So expect to see, against a swap dealer, 2-3% of shareholder funds, or sums in the order of hundreds of millions of dollars. For end users the number may well be a lot lower (especially for thinly capitalised investment vehicles like funds — like, ten million dollars or so — and, of course, will key off NAV, not shareholder funds.
For those noble, fearless and brave folk who think Cross Default is a bit gauche; a bit passé in these enlightened times of zero-threshold VM CSAs[1] but can’t quite persuade their credit department to abandon Cross Default altogether — a day I swear is coming, even if it is not yet here — one can quickly convert a dangerous Cross Default clause into a less nocuous (but still fairly nocuous, if you ask me — nocuous, and yet strangely pointless) cross acceleration clause — meaning your close-out right that is only available where the lender in question has actually accelerated its Specified Indebtedness, not just become able to accelerate it, with some fairly simple edits, which are discussed in tedious detail here.
Premium content
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- The JC’s famous Nutshell™ summary of this clause
- Dealer danger: why Cross Default is more of a boon than a bane, if you are a bank or dealer
- Specified Indebtedness, common tweaks, and the JC’s opinion thereof
- The Threshold Amount
- DUST v Cross Default: showdown
- The cherrypickability of individual bits of indebtedness to get you over the line and why this means you should not include derivatives
See also
References