GMSLA Netting
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Closing out a 2010 GMSLA is done following designation by a Non-Defaulting Party of an Event of Default under Paragraph 11.2 as follows:
11.2 in a Nutshell™ (GMSLA edition)
11.2 Acceleration: The Parties’ obligations will be accelerated as at the Event of Default (the Termination Date) as follows:
- (a) The Non-Defaulting Party will determine the Default Market Value of all amounts (and securities) due by each Party under paragraph 11.4 as at the Termination Date.
- (b) Using those values, [the Non-Defaulting Party will determine and notify][1]what each Party owes as at the Termination Date, converting into the Base Currency at the Spot Rate where necessary, and will set those sums off against each other. The Party owing the greater amount must pay the difference on the Business Day after notification.
- (c) and (d) [(d) being the vice-versa] If that balance is payable by a Party who had delivered a Letter of Credit to the other Party the other Party must draw on the Letter of Credit to settle the amount due and then deliver it for cancellation.
Gross Jurisdictions
Upon the insolvency of a Counterparty in a non-netting jurisdiction, provided a Non-Defaulting Party terminates each Loan individually under the "mini-closeout” method before it designates an Event of Default with respect to the whole Agreement, the worst-case scenario is to aggregate the market value of each “Loan” which is in the money to the Non-Defaulting Party (i.e., its net value having taken into account Posted Collateral held against that Loan), without taking into account the market value of any Loan which is out of the money for the Non Defaulting Party.
The “unit of account” under the GMSLA (the equivalent of a “transaction” under an ISDA Master Agreement) is a “Loan”, which is defined as a title transfer of Securities against a transfer of Collateral, with a simultaneous agreement to transfer back Equivalent Securities against Equivalent Collateral) Unless agreed otherwise, each Loan under a GMSLA is terminable by either party at any time without “cause”.
Each outstanding Loan is collateralised (by title transfer) daily, on an aggregated basis, but in a way which allows the Parties to deterministically assign Posted Collateral against each Loan.
Given that GMSLAs are margined daily, we would expect the market value of any Loan to be roughly equivalent to the “haircut” on the Posted Collateral for that Loan on any day. For example, where the Loaned Securities market value is 100% and the Posted Collateral value is 105%, the Loan value for the purposes of a mini-closeout would be 5%.
A party to a GMSLA has a general right to terminate any Loan at any time (thereby converting offsetting forward obligations into a single payment amount for that Loan), and could therefore terminate all Loans upon an insolvency without specifically invoking an Event of Default (although that right would also be available).
We reach this conclusion because a Party to a GMSLA has a general right to terminate any Loan at any time (thereby converting offsetting forward obligations into a single payment amount for that Loan), and could therefore terminate all Loans upon an insolvency without invoking an Event of Default (although that right would also be available).
Note that the position upon termination of the whole agreement expressly because of an Event of Default (without first having terminated each Loan per the above) is not quite as clear, as it does not specifically contemplate the termination of individual Loans as a stage of the close out process, but assumes all payments and deliveries will be netted down to a single figure.
Loan Definition
Under the GMSLA a “Loan” is defined as the transfer of securities from Lender to Borrower against a transfer of collateral by Borrower to Lender, with a simultaneous agreement to transfer back equivalent securities against equivalent collateral in the future.
Collateralisation
Collateral for Loan transactions is marked-to-market on a daily basis. In the market, such collateralisation operates on an “aggregated” basis across all outstanding Loans as is contemplated by Paragraph 5.4 of the GMSLA.
Where aggregated collateralisation under Clause 5.4 applies, Clause 5.6 contemplates “net” transfers of collateral on a daily basis (as a matter of settlement convenience), and Clause 5.7 provides that where the Parties do not specifically allocate specific Collateral deliveries to specific Loans, any new or substituted Collateral deemed to be transferred on any day will be attributed first to the earliest outstanding Loan (up to the point where that Loan is fully collateralised) and then to the next earliest outstanding Loan, and so on.
Therefore for the purposes of termination and close-out the value of Collateral held against each Loan at any time is able to be clearly determined.
Loan Termination
- Under clause 8.2 and 8.2 of the GMSLA, subject to the terms of any Loan*, either party may terminate any Loan at any time by calling for redelivery of Equivalent Securities (in the case of a Lender) or giving notice of redelivery of Equivalent Securities (in the case of a Borrower), in each case by title transfer.
- Delivery obligations are reciprocal, such that neither Party is obliged to make delivery unless it is satisfied the other party will make such delivery to it (cl 8.6), and an innocent party is entitled to suspend performance of its delivery obligation until satisfied the relevant delivery by its counterparty will be made.
- If a Party fails to deliver Equivalent Securities or Equivalent Collateral, the other party may elect either to continue the Loan (i.e., as suspended) or may by written notice declare that the Loan is terminated immediately as if an Event of Default had occurred with respect to that Loan only (note such a termination would not actually be an Event of Default under the GMSLA so let's call this a "quasi-Event of Default") and it was the only Loan outstanding.
This is important because it establishes a “transaction termination” methodology generating a market value for each transaction analogous to Section 6(e) of the ISDA Master Agreement.
Event of Default Close-out Methodology: Upon determining a “quasi-Event of Default” with respect to a single Loan the Non-Defaulting Party will determine the Default Market Value of the Equivalent Securities and Equivalent Collateral under that Loan, the relevant amounts will be offset to arrive at a balance payable by one party to the other in respect of that Loan on the next business day.
Under this analysis this procedure would be followed in respect of all outstanding Loans, to arrive at a series of “termination amounts”, one payable in respect of each Loan.
Clause 11.8 of the GMSLA purports to allow a Non-Defaulting Party to set such individual termination amounts off against each other and this clause is the one that might be challenged in insolvency in a gross jurisdiction.
Term Loans
Note term Loans may need to be treated differently, as the “without notice” termination right (under 8.1 and 8.2) will not necessarily apply. We recommend (i) updating template confirmation notices for term Loans to be clear that notwithstanding their term they are individually terminable upon any of the events listed in Events of Default (even where they have not been invoked) and (ii) updating template GMSLA schedules to include this provision.
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- ↑ Well, we assume it will be the NDP: the 2010 GMSLA rather brilliantly puts it into an unattributed passive, as if God is going to to it, or it will magically happen by itself. Go, ISLA’s crack drafting squad™.