Cross Default - ISDA Provision: Difference between revisions

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{{isdasnap|5(a)(vi)}}
{{newisdamanual|5(a)(vi)}}
 
{{nuts|2002 ISDA|Cross Default}}
 
===The difference between the two formulations===
====Measure of the Threshold====
* 1992 formulation talks about an default under an agreement “in an aggregate amount not less that the ... Threshold Amount which results in the Specified Indebtedness becoming due and payable”,
* 2002 formulation talks about default under agreements where the “aggregate principal amount” of the agreements is not less than the Threshold Amount.
 
This is a seemingly innocuous change intended to clarify a drafting lapse that, for example, of you defaulted on a (relatively small) interest payment on a loan, which then made the whole loan repayable, you could only count the value of the defaulted interest payment to your threshold, when in reality the whole size of the loan is in jeopardy, and really should have been what was counted. It is innocuous, that is, unless you are cavalier enough to include derivatives in your definition of {{isdaprov|Specified Indebtedness}}. But if you do that, you've bought yourself a wild old ride anyway.
 
The language in the second limb broadly replicates this distinction, but it is most certainly rather attention-sapping drafting.
 
===General===
 
 
''This article is specifically about the {{isdaprov|Cross Default}} provision in the {{isdama}}. See: [[cross default]] for a general discussion of the concept.
 
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.
 
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.
 
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.
 
===Cross Aggregation===
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.
 
As per the above, the two limbs are:
*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
*a failure to make any payments on their due date under such agreements or instruments after notice or the expiry of a grace period.
 
{{isdaanatomy}}

Latest revision as of 21:53, 30 December 2023

2002 ISDA Master Agreement

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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;

Related agreements and comparisons

Click here for the text of Section 5(a)(vi) in the 1992 ISDA
Click to compare this section in the 1992 ISDA and 2002 ISDA.

Resources and Navigation

This provision in the 1992

Resources Wikitext | Nutshell wikitext | 1992 ISDA wikitext | 2002 vs 1992 Showdown | 2006 ISDA Definitions | 2008 ISDA | JC’s ISDA code project
Navigation Preamble | 1 • (a) (b) (c) | 2 • (a) (b) (c) (d) | 3 • (a) (b) (c) (d) (e) (f) (g) | 4 • (a) (b) (c) (d) (e) | 5 • 5(a) Events of Default: 5(a)(i) Failure to Pay or Deliver 5(a)(ii) Breach of Agreement 5(a)(iii) Credit Support Default 5(a)(iv) Misrepresentation 5(a)(v) Default Under Specified Transaction 5(a)(vi) Cross Default 5(a)(vii) Bankruptcy 5(a)(viii) Merger Without Assumption 5(b) Termination Events: 5(b)(i) Illegality 5(b)(ii) Force Majeure Event 5(b)(iii) Tax Event 5(b)(iv) Tax Event Upon Merger 5(b)(v) Credit Event Upon Merger 5(b)(vi) Additional Termination Event (c) (d) (e) | 6 • (a) (b) (c) (d) (e) (f) | 7 | 8 • (a) (b) (c) (d) | 9 • (a) (b) (c) (d) (e) (f) (g) (h) | 10 | 11 | 12 • (a) (b) | 13 • (a) (b) (c) (d) | 14 |

Index: Click ᐅ to expand:
2002 ISDA
1992 ISDA

Overview

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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:

  1. a default under a financial agreement that would allow a creditor to accelerate any indebtedness that party owes it;
  2. a failure to pay on the due date under such agreements after the expiry of a grace period.

Summary

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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

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.

Threshold Amount

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.

Cross acceleration

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.

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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

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References

  1. ↑ Your correspondent is one of them; the author of that terrible FT book about derivatives is not.
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