Cross default: Difference between revisions

Cross default (view source)

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 :*This is problematic because of the accretive nature of the threshold: A single technical or operational failure may mean one is technically in default on payments which, if aggregated, could quickly exceed even a large threshold (especially in a heavily traded derivative master agreement).
 *Not, in the case of banks, excluding [[deposit|retail deposits]], where operational failure or even governmental action (like a moratorium or currency controls) could lead to technical default on a large amount of indebtedness. (Bank deposits are a form of indebtedness, and will almost certainly be a significant source of indebtedness for any trading bank).
-*Adding in [[grace period]]s or other preconditions, excuses, permission to skip PE class and so on, before a party is entitled to invoke a [[cross default]];
+*Adding in [[grace period]]s or other preconditions, excuses, permission to skip PE class and so on, before a party may invoke a [[cross default]];
 *Arguing the toss about [[threshold amount]]s (should it be shareholders funds or cash? or both? lower or higher of? Is my threshold higher than yours? Is it too big? Is it too small? Does my {{isdaprov|Threshold Amount}} look big in this? Honestly it is so tedious).
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 Cross default is potentially a very damaging clause, as this picture to the right amply illustrates. Or would do, if there were a picture to the right. To the extent it doesn't:
-===Cross Default===
+===Cross default===
-a cross default provision against a party imports into the [[ISDA]] all of the termination rights upon default under any {{isdaprov|Specified Indebtedness}} owed by that party:
+A cross default right effectively imports into the [[ISDA]] all the default termination rights under any {{isdaprov|Specified Indebtedness}} owed by a party:
-*It has the effect of dramatically (and indeterminately) widening the definition of Event of Default.
+*It dramatically (and indeterminately) widens the definition of {{isdaprov|Event of Default}}.
-*Cross default entitles a [[Counterparty]] to [[cross accelerate|accelerate]] the ISDA whether or not the Specified Indebtedness in question itself has been accelerated.
+*It entitles a [[Counterparty]] to [[cross accelerate|accelerate]] the {{tag|ISDA}} whether or not the {{isdaprov|Specified Indebtedness}} itself has been accelerated.
-*Depending on the market value of the transactions under the ISDA at the time of termination, therefore exercise of a cross default may lead to an immediate capital outflow.
+*Depending on the market value of the {{isdaprov|transaction}}s under the ISDA it may cause an immediate capital outflow (though is less likely to in these days of compulsory variation margin).
-===Specified Indebtedness===
+==={{isdaprov|Specified Indebtedness}}===
 {{isdaprov|Specified Indebtedness}} means, generally, any [[borrowed money|borrowings]] that, in aggregate, exceed a designated {{isdaprov|Threshold Amount}}. Because of the aggregation right, even comparatively trivial agreements can trigger the provision where they are relatively homogenous and affected by the same local circumstances (for example, [[retail deposit]]s). A low {{isdaprov|Threshold Amount}}, therefore, presents three challenges:
 *It allows a more varied (and difficult to monitor) range of potential termination rights, because a greater number of agreements will qualify as {{isdaprov|Specified Indebtedness}}.
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 *Note that [[repo]] is not considered {{isdaprov|Specified Indebtedness}}: see [[borrowed money]]. But don’t let your inner anal retentive amending the definition in your {{isdaprov|Schedule}} so that it is (even though [[repo]] is more properly dealt with by {{isdaprov|DUST}}).
-===Derivatives as Specified Indebtedness===
+===[[Derivatives]] as {{isdaprov|Specified Indebtedness}}===
+Be wary of including derivatives in the definition of {{isdaprov|Specified Indebtedness}}, no matter how hight the {{isdaprov|Threshold Amount}} (we would say ''never'' do it, but realistically this sort of thing is controlled by “wise senior heads” in the [[credit department]] whose minds will be well beyond the calming influence of most jobbing negotiators, so you may well be stuck with it).
-Derivatives should '''never''' be included in the definition of {{isdaprov|Specified Indebtedness}}, no matter how hight the {{isdaprov|Threshold Amount}}. the Cross Default language aggregates up all individual defaults, so even though a single ISDA would be unlikely to have a net out-of-the-money MTM of anything like 3% of shareholder funds, a large number of them taken together may, particularly if you’re selective about which ones you’re counting. Which the cross default language entitles you to be.
+The {{isdaprov|Cross Default}} language aggregates up all individual defaults, so even though a single ISDA would be unlikely to have a ''net'' out-of-the-money [[MTM]] of anything like 3% of shareholders’ funds, a large number of individual transactions if aggregated may, particularly if you’re selective about which transactions you’re counting — which the cross default language entitles you to be.
-Thus, where you have a number of small failures, you can still theoretically have a big problem.  This is why we don’t include deposits: operational failure or regulatory action in one jurisdiction can create an immediate problem.
+Thus, where you have a large number of small failures, you can still have a big problem. This is why we don’t include deposits: operational failure or regulatory action in one jurisdiction can create an immediate problem.
 The same could well be true for derivatives. Individual net [[MTM]]s under derivative [[ISDA Master Agreement|Master Agreement]]s can be very large. We have a lot of Master Agreements (18000+).