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Events of Default - GMSLA Provision: Difference between revisions
→The purpose of {{gmslaprov|Events of Default}}
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Making delivery failures an {{gmslaprov|Event of Default}} would put participants in a perpetual state of default for reasons not necessarily related to the solvency or creditworthiness of the "failing" counterparty. | Making delivery failures an {{gmslaprov|Event of Default}} would put participants in a perpetual state of default for reasons not necessarily related to the solvency or creditworthiness of the "failing" counterparty. | ||
===The purpose of {{gmslaprov|Events of Default}}=== | |||
{{gmslaprov|Events of Default}} are protections for use if a counterparty is in a potentially insolvent position. A non-defaulting party is able to immediately terminate '''all''' outstanding transactions prior to upon an {{gmslaprov|Event of Default}} and so end its exposure. | |||
They are {{isdaprov|not}} intended for breaches where the creditworthiness of a counterparty is not in question. Here, the parties can rely on the normal contractual remedies for breach of contract. | |||
Allowing a party to declare an {{gmslaprov|Event of Default}} allows extraordinary leverage over a minor breach – a failure to comply with a trivial term of the contract would allow a party to threaten to terminate all outstanding transactions. In the context of frequent delivery failures in a stock lending relationship, the moment a party wants to end the relationship it could pick one of the many delivery failures as grounds to terminate all trades and inflict considerable loss on the other party. | |||
Importantly, the failures to deliver unrelated to solvency vastly outnumber those related to solvency. If a party wished to treat a failure to deliver as an indicator of insolvency, the instances where a true concern existed would be swamped by the false alarms where the delivery failure didn’t indicate a cause for concern. | Importantly, the failures to deliver unrelated to solvency vastly outnumber those related to solvency. If a party wished to treat a failure to deliver as an indicator of insolvency, the instances where a true concern existed would be swamped by the false alarms where the delivery failure didn’t indicate a cause for concern. | ||
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A contrast must be drawn between delivery failures of the underlying security and delivery failures concerning collateral. A party has a choice whether to deliver securities as collateral. The party can select which collateral to deliver, and so can control the process better. If a party takes that choice and fails to deliver, the expected recipient is entitled to consider that the failure may represent a credit concern. In the market generally, most participants use cash collateral to avoid the risks involved with using securities as collateral. | A contrast must be drawn between delivery failures of the underlying security and delivery failures concerning collateral. A party has a choice whether to deliver securities as collateral. The party can select which collateral to deliver, and so can control the process better. If a party takes that choice and fails to deliver, the expected recipient is entitled to consider that the failure may represent a credit concern. In the market generally, most participants use cash collateral to avoid the risks involved with using securities as collateral. | ||
Why does the GMSLA take a different approach to the OSLA? | ===Why does the {{gmslaprov|GMSLA}} take a different approach to the {{gmslaprov|OSLA}}?=== | ||
When the GMSLA was being drafted in 1999, the International Stock Lenders’ Association released a draft that made a redelivery failure an Event of Default. ISLA members were concerned at the frequency with which borrowers failed to return securities at the end of loans, and wanted to tighten up on this. The London Investment Bankers’ Association (representing the intermediary market) responded that this was unreasonable. ISLA was determined that the Event of Default must remain, and as a compromise made a delivery failure to initiate a loan an Event of Default as well. This went against what lenders did in practice, as no lender would consider that if it failed to deliver to commence a loan that it had breached contract, let alone caused an Event of Default. Only if the lender agreed “guaranteed delivery” would a borrower consider that there was a breach of contract for a failure to deliver. Unfortunately, the final published version made all failures to deliver an Event of Default, and as a consequence the intermediary market generally has had to adopt the approach of amending the GMSLA to disapply a delivery failure being an Event of Default. | When the {{gmslaprov|GMSLA}} was being drafted in 1999, the [[International Stock Lenders’ Association]] released a draft that made a redelivery failure an {{gmslaprov|Event of Default}}. ISLA members were concerned at the frequency with which borrowers failed to return securities at the end of loans, and wanted to tighten up on this. The London Investment Bankers’ Association (representing the intermediary market) responded that this was unreasonable. ISLA was determined that the Event of Default must remain, and as a compromise made a delivery failure to initiate a loan an Event of Default as well. This went against what lenders did in practice, as no lender would consider that if it failed to deliver to commence a loan that it had breached contract, let alone caused an Event of Default. Only if the lender agreed “guaranteed delivery” would a borrower consider that there was a breach of contract for a failure to deliver. Unfortunately, the final published version made all failures to deliver an Event of Default, and as a consequence the intermediary market generally has had to adopt the approach of amending the GMSLA to disapply a delivery failure being an Event of Default. | ||
What is the protection for an expected recipient if a delivery failure occurs? | ===What is the protection for an expected recipient if a delivery failure occurs?=== | ||
Deliveries in stock lending typically occur free of payment, with the cash moving after the shares are confirmed as settling. This is for 3 principal reasons: | Deliveries in stock lending typically occur free of payment, with the cash moving after the shares are confirmed as settling. This is for 3 principal reasons: | ||
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(ii) If the failure was by the borrower at the end of the loan, the lender would not return the cash, and each party has the same exposure that it did the previous day (other than market movements on the securities). | (ii) If the failure was by the borrower at the end of the loan, the lender would not return the cash, and each party has the same exposure that it did the previous day (other than market movements on the securities). | ||
The correct approach is that under the OSLA agreement: | |||
1. A delivery failure by a lender when initiating a loan has no consequence – it is neither an Event of Default, nor a breach of contract. | 1. A delivery failure by a lender when initiating a loan has no consequence – it is neither an Event of Default, nor a breach of contract. | ||
2. A redelivery failure by a borrower at the end of the loan is not an Event of Default. Rather, the lender is free to buy in the securities using the procedure under section 9.4 of the GMSLA. | 2. A redelivery failure by a borrower at the end of the loan is not an Event of Default. Rather, the lender is free to buy in the securities using the procedure under section 9.4 of the GMSLA. | ||
3. A failure by either party to deliver collateral when required is an Event of Default. | 3. A failure by either party to deliver collateral when required is an Event of Default. | ||
This correctly addresses the credit concerns that a party may justifiably have under a stock lending relationship, while also reflecting the intentions of the transacting parties when entering into securities loans. | |||
{{gmslaanatomy}} | |||