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Cross default: Difference between revisions
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==History== | ==History== | ||
[[Cross default]] developed in the loan market. If a [[lender]] advanced a large sum to a [[borrower]] with only periodic interest or principal repayments, there would be long periods — months, quarters or even ''years'' — where the borrower was not scheduled to make any payments to the Lender at all. | |||
Now a borrower that is not due to pay anything, can hardly [[Failure to pay|fail to pay]]. | |||
This presented the lender with a risk: if, in the mean time, his borrower failed to pay interest or principal under a loan from ''another'' lender, our lender would be in a difficult spot: the borrower hasn’t defaulted on his own loan, but he has good reason to worry that the borrower is in trouble. Waiting a month for the next interest instalment, to see if the borrower will meet it, really won’t do. Our borrower wants to accelerate its loan ''now''. Nor did it want to wait for the other lender to actually accelerate its loan: it would rather get in while the going was still tolerably good. | |||
Whence came the notion of a [[cross default]]: | |||
So the two main reasons for inserting a cross default aren't really there in an | :''If you default under a loan you have borrowed from someone else, you default under your loan with me.'' | ||
This is a drastic measure. It means any lender is going to be trigger happy. Therefore some thresholds were put around it: The size of the loan being defaulted on would need to be material enough to threaten the borrower’s very solvency. | |||
Note the key "vulnerabilities" of a lender that a [[cross default]] clause is designed to protect against: | |||
*'''Material indebtedness''': Our lender's contract is one where it takes significant credit exposure to the borrower; | |||
*'''Infrequent payments''': Our lender is owed infrequent payment obligations and canot therefore rely on a [[failure to pay]]. | |||
*''Material default''': The borrower may default on ''other'' indebtedness in a size big enough to threaten its own viability. | |||
A counterparty to an {{isdama}}, particularly one with a zero-threshold daily {{isdaprov|CSA}} and many {{isdaprov|transaction}}s under it, suffers none of those weaknesses. | |||
*'''Little indebtedness''': An {{isdama}} is not a contract of [[indebtedness]], and any [[mark-to-market]] exposure that may ''resemble'' indebtedness is zeroed daily by means of a collateral call; | |||
*'''Frequent payments''': particularly where there are many transactions, or where the net mark-to-market position is shifting, there are payment obligations flowing every day, ''and if there are not that means there is no net indebtedness at all to the counterparty''. | |||
So the two main reasons for inserting a cross default aren't really there in an a collateralised trading agreement. For a bank, there are key treasury concerns about giving away a cross default, because it can affect our liquidity buffer calculations, but credit to date has not been persuaded to worry about these. | |||
DUST, on the other hand, is between just the two parties, and here any direct failure to us under any transaction, whether or not under the ISDA should allow us to close out the ISDA (just as a payment default under the ISDA itself would). The better your dust, the less need, in fact, you have for a cross default. Dust doesn’t need to cover indebtedness because it’s covered already by default, but you’re right – it’s slightly odd that indebtedness between parties is excluded from specified transactions – but there you have it. | DUST, on the other hand, is between just the two parties, and here any direct failure to us under any transaction, whether or not under the ISDA should allow us to close out the ISDA (just as a payment default under the ISDA itself would). The better your dust, the less need, in fact, you have for a cross default. Dust doesn’t need to cover indebtedness because it’s covered already by default, but you’re right – it’s slightly odd that indebtedness between parties is excluded from specified transactions – but there you have it. | ||
==Introduction== | ==Introduction== | ||