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This is a page about the general concept of [[cross default]].  
{{a|banking|[[File:Crossing Threshold Hope.jpg|450px|thumb|center|an equally forlorn attempt to influence matters beyond one's control]]}}This is a page about the general, generally stupid, concept of {{t|cross default}}.  
==Before we start==
===As a standard term in [[master trading agreement|master trading agreements]]===
===As a standard term in master trading documents===
For specific provisions see:
For specific provisions see:
*{{isdaprov|Cross Default}} ({{tag|ISDA}})
*{{isdaprov|Cross Default}} ({{tag|ISDA}})
*{{gtmaprov|Cross Default}} ([[GTMA]])
*{{efetprov|Cross Default}} ([[EFET]])
*{{fbfprof|Cross Default}} ([[FBF]])
*{{fbfprof|Cross Default}} ([[FBF]])
*'''Stock lending and repo have no cross default''': Neither the {{gmsla}} nor the {{gmra}} have, as standard, either a [[cross default]] or a [[default under specified transaction]] provision.
*'''[[Cross Default - GMSLA Provision|Stock lending and repo have no cross default]]''': Neither the {{gmsla}} nor the {{gmra}} have, as standard, either a [[cross default]] or a [[default under specified transaction]] provision. ''[[Cross Default - GMSLA Provision|Unless some bright spark thinks it is a good idea to negotiate one in]].''


===Compare and contrast===
===Compare and contrast===
*'''[[Default under specified transaction]]''': Like cross default, but just between you and me, on [[derivative]] transactions and without a {{isdaprov|Threshold Amount}};
*'''[[Default under specified transaction]]''': {{t|DUST}} is ''like'' [[cross default]], but just between you and me, on [[derivative]] transactions and without a {{isdaprov|Threshold Amount}};
*'''[[Cross acceleration]]''': like [[cross default]], only for a kinder, gentler world where people wait for indebtedness to be actually [[accelerated]] before closing out their exposures.
*'''[[Cross acceleration]]''': like [[cross default]], only for a kinder, gentler world where people wait for [[indebtedness]] to be actually [[accelerated]] before closing out their exposures.


==History==
==History==
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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).
:*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).
*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).
*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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* [[default under specified transaction]] which references default under financial contracts which do '''not''' represent indebtedness, but only as between the two counterparties to the present contract.
* [[default under specified transaction]] which references default under financial contracts which do '''not''' represent indebtedness, but only as between the two counterparties to the present contract.


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 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:  
{{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}}.  
*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}}).
*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 specified indebtedness|isdaprov}}
 
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.
 
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.
 
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+).
 
Say we have an operational failure (triggering a regulatory announcement, therefore public) or a government action in a given jurisdiction preventing us from making payments on all derivatives in that jurisdiction. We could have technical events of default on a large number of agreements at once – unlikely to be triggered, but for a cross default, that doesn’t matter.
 
The net MTM across  all those agreements may well not be significant. But an opportunistic counterparty could tot up all the negative mark to markets, ignore the positive ones, and reach a large number very quickly.
 
Cross Default is a banking concept intended to reference borrowed money - indebtedness etc - and it really doesn’t make economic sense to apply it to derivatives – the fact that there’s a cross default in derivatives documentation at all is something of a historical accident. There are good points made below about the difficulty of calculating it and knowing what to apply it to ([[MTM]]? {{isdaprov|Termination Amount}}? Payments due on any day?) – bear in mind these values are not nearly as deterministic as amounts due wrt borrowed money: on a failure of a derivative contract the valuation of the termination amount (off which {{isdaprov|Cross Default}} would calculate) is extremely contentious. The market is still in dispute with Lehman, for example.


===Credit Mitigation===
===Credit Mitigation===
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===Contagion risk===
===Contagion risk===
It is important to maintain minimum standards which are reflective of genuine credit concerns against the bank so as to limit a “snowball” effect: were we to allow a £50mm Threshold Amount, we would potentially be open to a large number of derivative counterparties simultaneously (and opportunistically) closing out out-of-the-money derivatives positions, which in itself could have massive liquidity and capital implications.
It is important to maintain minimum standards which are reflective of genuine credit concerns against the bank so as to limit a “[[snowball effect|snowball]]” effect: were we to allow a £50mm {{isdaprov|Threshold Amount}}, we would potentially be open to a large number of derivative counterparties simultaneously (and opportunistically) closing out [[out-of-the-money]] derivatives positions, which in itself could have massive liquidity and capital implications.
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