Market Disruption Events Generally - Equity Derivatives Provision
2002 ISDA Equity Derivatives Definitions
Section 6.3 in a Nutshell™
Use at your own risk, campers!
Full text of Section 6.3
Content and comparisons
Article 6. Valuation
Section 6.1. Valuation Time
Section 6.2. Valuation Date
Section 6.3. General Terms Relating to Market Disruption Events
- 6.3(a) Market Disruption Event
- 6.3(b) Trading Disruption
- 6.3(c) Exchange Disruption
- 6.3(d) Early Closure
Section 6.4. Disrupted Day
Section 6.5. Scheduled Valuation Date
Section 6.6. Consequences of Disrupted Days
Section 6.7. Averaging
- 6.7(a). Averaging Date
- 6.7(b). Settlement Price and Final Price
- 6.7(c). Averaging Date Disruption
- 6.7(d). Adjustments of the Exchange-traded Contract
- 6.7(e). Adjustments to Indices (Averaging)
Section 6.8. Futures Price Valuation
- 6.8(a) Valuation Date (Futures Price Valuation)
- 6.8(b) Additional definitions (Futures Price Valuation)
- 6.8(c) Settlement Price and Final Price (Futures Price Valuation)
- 6.8(d) Adjustments of the Exchange-traded Contract (Futures Price Valuation)
- 6.8(e) Non-Commencement or Discontinuance of the Exchange-traded Contract
- 6.8(f) Corrections of the Official Settlement Price
Market Disruption Events is part of Section 6 (Valuation) in the 2002 ISDA Equity Derivatives Definitions, so this isn’t really about catastrophic, end-of-days events that might bring your Transaction to an unexpected, premature end. For that you should look to Section 12, and especially 12.8 and 12.9.
A Market Disruption Event is a Trading Disruption or Exchange Disruption that exists during the hour before any Valuation Time or Exercise Time — it keys off the occurrence or existence of the event, not the point when the Calculation Agent determined it — or Early Closure.
The point is to capture material disruptions around the close of the market. If there was a disruption, earlier in the day but, say, it cleared up by lunchtime, then — as far as valuing equity derivatives is concerned — all is Kool and the Gang. The kinds of disruptions are:
- Trading Disruption: suspension/limitation in trading on an underlier (or futures on it) on any Exchange/Related Exchange
- Exchange Disruption: any event that impairs the ability to value, settle transactions across any Exchange/Related Exchange
- Early Closure: the closure of any Exchange/Related Exchange prior to scheduled closing time unless announced at least one hour prior to the earlier of (i) the actual closing time for the regular trading session on that exchange and (ii) the submission deadline for orders on Exchange for execution at the Valuation Time
Additionally a day is “Disrupted Day” if an Exchange/Related Exchange fails to open for trading during a regular trading session.
Market Disruption Events vs Additional Disruption Events showdown
In a Nutshell™:
- Market Disruption Events (Section 6.3) handle difficulties in valuing ongoing Transactions in a disrupted market — where the parties are happy to carry on with the position, but their practical means of marking-to-market (and therefore margining) their exposures under the Transactions is hampered because of market dislocation;
- Additional Disruption Events (Section 12.9) handle your rights to early-terminate Transactions, usually because their ability to properly risk-manage their positions — i.e., hedge — is undermined by the market dislocation.
So the two are independent: one is where you want to carry on; one where you don’t. So you don't have to wait for a period of Exchange Disruption before invoking a Hedging Disruption, and conversely you could — in theory at any rate — designate an Exchange Disruption even if there were no Hedging Disruption in existence.
Now in point of fact, an Exchange Disruption — especially a long one — usually will count as a Hedging Disruption which might be why the Consequences of Disrupted Days wording in Section 6.6 seems to run out of enthusiasm for its own existence, as if ISDA’s crack drafting squad™ suddenly realised the whole world is futile and threw in the towel. After all, if there have been eight straight Disrupted Days, the likelihood that one or other party hasn’t canned the Transaction on the grounds of Hedging Disruption must be pretty low.
Synthetic prime brokerage
The Valuation Date comes in handy if you are restriking your Transactions periodically, as you are likely to be doing if you are providing synthetic prime brokerage — being as it is, an undated delta-one exposure to equities delivered through an equity derivative.
Your prime broker will not want to run indeterminate exposures to shares, even if it is collateralised daily, so restriking the transactions periodically can zero out whatever the residual risk is in the paranoid eyes of your financial controllers.
Now interim Valuation Dates — which are glorified estimates of the present value of an ongoing position — and the final Valuation Date — which is the price at which you definitively close out your position and go “off risk” — have rather different consequences. US Tax attorneys, as obsessed as they are with avoiding the suggestion that a swap counterparty is controlling its broker’s hedge, will seek to avoid any suggestion that the final, scheduled valuation arises from anything quite so mucky as the price at which the broker closes out its hedge. So, there, expect references to VWAP.
The same tax attorney will not be so bothered how you come up with your prices on other Valuation Dates, seeing as on that theory of the game, the counterparty is not going on or off risk.
In the synthetic prime brokerage world, where Transactions are callable at will, that scheduled Termination Date is a fairly arbitrary figure plucked out of the air at some point in the distant future, as much as anything else because “Termination Date” is a mandatory field in your PB’s booking system. Also, to quiet the black horses of despair playing through the wild paddocks of your financial controller’s tortured psychology. It won’t, of course, but you can always try.
Curiously, tax attorneys are less exercised about the method by which a Broker values the transaction for an optional early termination, even though that is the usual method by which a client terminates a synthetic equity swap, which is broadly an undated transaction terminable at the client’s whim.
- Consequences of Disrupted Days (Section 6.6)
- Additional Disruption Events (Section 12.9)