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| {{isdaanat|5(a)(vi)}}''This article is specifically about the {{isdaprov|Cross Default}} provision in the {{isdama}}. For a general discussion of the concept, see [[cross default]]. | | {{newisdamanual|5(a)(vi)}} |
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| ''Want to quickly convert {{isdaprov|Cross Default}} to {{isdaprov|Cross Acceleration}}? Click '''[[Cross Acceleration - ISDA Provision|here]]'''.''<br>
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| ===General===
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| {{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 to apply it to contractual relationships which aren't debtor/creditor in nature — as starry-eyed young [[credit officer]]s in the thrall of the moment like to — it will give cause trouble. This will not stop credit officers doing that. Note also that it is, as are most ISDA provisions, bilateral. If you are a regulated financial institution, the boon of having a {{isdaprov|Cross Default}} right against your counterparty may be a lot smaller than the bane of having given away a {{isdaprov|Cross Default}} right against yourself.
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| Under the {{isdama}}, if the cross default applies, default by a party under a contract for “{{isdaprov|Specified Indebtedness}}” with a third party in an amount above the “{{isdaprov|Threshold Amount}}” is an {{isdaprov|Event of Default}} under the {{isdama}}.
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| {{isdaprov|Specified Indebtedness}} is generally any [[borrowed money|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.
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| The {{isdaprov|Threshold Amount}} is usually defined as a cash amount or a percentage of shareholder funds. It should be big: be a life-threatening failure - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or sums in the order of hundreds of millions of dollars.
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| {{isdaprov|Cross default}} imports all the default rights from the {{isdaprov|Specified Indebtedness}} into the {{isdama}}. For example, if you breach a financial covenant in your Specified Indebtedness, your swap counterparty could close you out '''even if the lender of the facility took no action on the breach'''. Cross default is, therefore, theoretically at least, a very dangerous provision. Financial reporting dudes get quite worked up about it. Oddly enough, it is very rarely triggered: It is actually very nebulous, and most credit officers would prefer to act on a clean {{isdaprov|Failure to Pay}} or a {{isdaprov|Bankruptcy}} event. Generally one will be along presently.
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| ===Cross Aggregation===
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| The {{2002ma}} updates the {{1992ma}} cross-default so that if the combined amount outstanding under the two limbs of {{isdaprov|Cross Default}} exceed the {{isdaprov|Threshold Amount}}, then it will be an {{isdaprov|Event of Default}}. Normally, under the {{1992ma}}, {{isdaprov|Cross Default}} requires one ''or'' the other limbs to be satisfied — you can’t add them together.
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| As per the above, the two limbs are:
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| *a default under a financial agreement that would allow a creditor to [[accelerate]] any [[indebtedness]] that party owes it;
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| *a [[failure to pay]] on the due date under such agreements after the expiry of a [[grace period]].
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| {{DUST and Cross Default Comparison}}
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| ===The difference between the two formulations===
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| [[File:Crossing Threshold Hope.jpg|thumb|left|About as much use as a cross default clause]]
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| ====Measure of the Threshold====
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| *'''{{1992ma}}''': 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 value of the failed payment, and not the whole principal amount of the {{isdaprov|Specified Indebtedness}} it was owed under, contributes to the {{isdaprov|Threshold Amount}}, ;
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| *'''{{2002ma}}''': 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 from {{icds}}:
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| *It can be triggered by any [[event of default]], not just a payment default (i.e. the {{1992ma}} requirement for "an {{isdaprov|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 value of the {{isdaprov|Specified Indebtedness}}, not just the value of the default (if it even ''is'' a payment capable of being valued) itself.
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| For example: if you defaulted on a small interest payment on your {{isdaprov|Specified Indebtedness}} which made your whole loan repayable, under the {{1992ma}} you could only count the value of that missed interest payment to your {{isdaprov|Threshold Amount}}. But the whole loan is at risk of being accelerated — so this is a much more significant credit deterioration than is implied by the missed payment.
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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 {{isdaprov|Specified Indebtedness}}. But if you do that, you've bought yourself a wild old ride anyway.
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| Don't say you weren't warned.
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| {{sa}}
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| *[[Cross acceleration]]
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| {{ref}}
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2002 ISDA Master Agreement
A Jolly Contrarian owner’s manual™
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The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack.
| 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
Here the free bit runs out. Subscribers click 👉 here. New readers sign up 👉 here and, for ½ a weekly 🍺 go full ninja about all these juicy topics 👇 |
- 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