ISDA Comparison

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ISDA Anatomy

incorporating our exclusive ISDA in a NutshellTM


Resources Wikitext | Nutshell wikitext | 1992 ISDA wikitext | 2002 vs 1992 Showdown | 2006 ISDA Definitions | 2008 ISDA | JC’s ISDA code project
Navigation Preamble | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13 | 14
Events of Default: 5(a)(i) Failure to Pay or Deliver5(a)(ii) Breach of Agreement5(a)(iii) Credit Support Default5(a)(iv) Misrepresentation5(a)(v) Default Under Specified Transaction5(a)(vi) Cross Default5(a)(vii) Bankruptcy5(a)(viii) Merger without Assumption
Termination Events: 5(b)(i) Illegality5(b)(ii) Force Majeure Event5(b)(iii) Tax Event5(b)(iv) Tax Event Upon Merger5(b)(v) Credit Event Upon Merger5(b)(vi) Additional Termination Event

Index — Click ᐅ to expand:

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So, you were wondering “what are the main differences between the 1992 ISDA and the 2002 ISDA?” Well, funny you should ask. I had the same question once upon a time, so I found out. They are below.[1]

Close-out method

The 2002 ISDA, with its Close-Out Amount, is way simpler than the 1992 ISDA which gets bogged down with all this Loss, Market Quotation, First Method, Second Method malarkey. See Section 6(e)(i) - 1992 ISDA provision for more detail though, trust me, if you do you will lament the hours of your life you will never get back.

Two way payments only

The 1992 ISDA offered parties the choice between the outrageous one-way payment (the “First Method”) where only an innocent party could realise its net mark-to-market gain; and two-way payment (the “Second Method”) of the Settlement Amount following early termination, where a Non-defaulting Party could nonetheless find itself having to pay the Defaulting Party on close-out under the 1992 ISDA, where it was overall out-of-the-money on its Transactions. Seeing as no-one with a functioning frontal lobe would (or, in the ten years of the 1992 ISDA, did) agree to the First Method, the 2002 ISDA ditched it and provided instead for only two-way payment, under the “Close-out Amount” concept. Few tears were shed, though the famous transaction manager at a certain US house who, to this day, still insists on the 1987 ISDA, must have bridled a bit.

Valuation Method

Likewise, the election of the counter-intuitive and needlessly convoluted Loss/Market Quotation methods in the 1992 ISDA has been replaced with a hybrid valuation method called Close-Out Amount. Close-Out Amount was established in response to the following concerns:

  • Reliability: Market Quotation was unreliable (in that few Reference Market-makers would bother putting in a quote) and potentially inaccurate (in that those that did had no skin in the game and could just put in any number they liked, knowing it was never going to be traded on), especially in illiquid markets or at times of market stress (being the typical situations in which you would be closing out ISDA Master Agreements), and
  • Objectivity: the inherent subjectivity of the Loss valuation method. Close-Out Amount is a calculation of the gains, losses, and costs incurred in replacing or realizing the economic equivalent of the Terminated Transactions including (i) the cost of terminating, liquidating or re-establishing hedges so long as this value does not duplicate any other amount already included in the Close-Out Amount calculation; and (ii) the value of the option rights of the parties.
  • Valuation Process: The Determining Party enjoys flexibility in its choice of price sources, including the option to use internal valuations so long as the internal information used is of the same type used in valuing similar Transactions in the ordinary course of its business. However, regardless of the valuation method used, the Determining Party must use third party quotations or market data in its valuations unless it believes the information is not available or would not provide commercially reasonable results. The Determining Party may consider its creditworthiness and any Credit Support Document ation existing between the Determining Party and the entity providing the quotation when obtaining Market Quotations.
  • Force Majeure: Special considerations exist when the Close-Out Amount is calculated following termination due to a Force Majeure or Illegality. When calculating the Close-Out Amount for an Illegality or a Force Majeure, mid-Market Quotations must be used to value the Termination Transaction, and the creditworthiness of the Determining Party may not be considered. The 2002 ISDA requires the Determining Party to use “commercially reasonably procedures to produce a commercially reasonable result” when calculating the Close-Out Amount. This calculation method may be less attractive to some parties than the old Loss method due to concerns that this requirement adds uncertainty and limits the Determining Party ’s discretion in calculating the Close-Out Amount.

Illegality and Force Majeure Termination Events

Although the 2002 ISDA preserves most of the 1992 ISDA’s provisions concerning Termination Events, it extensively changes Illegality and adds Force Majeure as a Termination Event.

  1. if an occurrence would constitute an Illegality and a Force Majeure, the occurrence will be treated as an Illegality ;
  2. if an occurrence would constitute an Illegality or Force Majeure and an Event of Default under Section 5(a)(i), Section 5(a)(ii)(1), or 5(a)(iii)(1), it will be treated as an Illegality or Force Majeure so long as the occurrence relates to a failure to make any payment or delivery, failure to comply with a material term of the Agreement, or a failure to comply with a material provision of the 2002 ISDA or any Credit Support Document ; and
  3. if an occurrence would constitute an Illegality or Force Majeure and an Event of Default (other than an Event of Default as described in clause (ii)) or Other Termination Event, then it will be treated as the applicable Event of Default or Other Termination Event and not as a Force Majeure or Illegality

Events of Default

The Events of Default in the 1992 ISDA were not massively changed in the 2002 ISDA. Some revisions were made to reflect changes in market practice (by which parties would religiously, tediously, amend their 1992 Schedules) including:

Cure Periods

Some of the cure periods were reduced out of the concern that these cure periods create undue risk when market volatility increases in times of turmoil in the financial markets. This was addressed in the 2002 ISDA by reducing the cure periods:

Breach of Agreement

An additional subsection has been added to the Breach of Agreement Event of Default (Section 5(a)(ii) that establishes an Event of Default when “the party disaffirms, disclaims, repudiates or rejects, in whole or in part, or challenges the validity of, this Master Agreement, any Confirmation executed and delivered by that party or any Transaction evidenced by such a Confirmation (or such action is taken by any person or entity appointed or empowered to operate it or act on its behalf).” Although this additional subsection is part of Section 5(a)(ii), the 30 day cure period applies only to Section 5(a)(ii)(1) and not to the new subparagraph (2). This new Event of Default is similar to the Credit Support Default Event of Default in Section 5(a)(iii)(3) of the 1992 ISDA, which was also included in the 2002 ISDA.

DUST

DUST has been expanded in five significant ways by the 2002 ISDA:

  • The phrase “or challenges the validity of” was added after “disaffirms, disclaims, repudiates or rejects” to reduce ambiguity as to whether a party’s action constitutes a repudiation; and
  • to stiffen the criteria for something to count as a repudiation so as to require written evidence from the repudiating party of its extended middle finger. This is really an articulation of common sense, for it would be a brave risk officer indeed who closed out an ISDA Master Agreement based on an oral communication, or the proverbial extended middle finger, for which she could not subsequently produce in fairly compelling evidence. But still.
  • Widened definition of Specified Transaction: The “Specified Transaction” concept has been broadened to include additional transaction types such as repos, and to include a catchall clause designed to include any future derivative products that have not been thought of yet.

Cross Default

The formula for determining a Cross Default has been revised to permit the aggregation of amounts owed under multiple defaults. In determining whether the Cross Default threshold has been exceeded, the principal amount of the accelerated obligations in subparagraph (i) and the unpaid amount under subparagraph (ii) are added together to determine whether the Cross Default threshold has been exceeded. In the 1992 ISDA, subparagraphs (i) and (ii) could not be combined to evidence a Cross Default.

Merger Without Assumption

The types of events that constitute a “merger” have been broadened to include reorganization, reincorporation and reconstitution, and the methods by which a resulting, surviving or transferee entity can assume obligations have been deleted.

Credit Support Default

The failure of a security interest granted pursuant to a Credit Support Document now constitutes a Credit Support Default.

Set-Off

The absence of a Set-Off provision is seen by many as the biggest weakness of the 1992 ISDA. Although the User’s Guide to the 1992 ISDA included an optional Set-Off provision, the optional provision was not effective unless the parties added the provision to the Schedule to the 1992 ISDA. The 2002 ISDA remedies this concern by including a Set-Off provision that is similar to the provision included in the User’s Guide. This provision permits the Non- Defaulting Party to Set-Off any amounts owing between the parties against any early termination amount. While cross-product Set-Off is permitted, cross-affiliate Set-Off is not incorporated into this provision. The User’s Guide also suggested adding a representation to satisfy the requirement that mutuality must exist between the parties for a Set-Off to be effected. In response to this concern, the 2002 ISDA includes an additional representation in Section 3(g) that both parties are principals in respect of all Transactions.

References

  1. What is that you say? You weren’t wondering about the differences between the 1992 ISDA and the 2002 ISDA? Well, in that case you might like Otto Büchstein’s uncelebrated opera, La Vittoria della Forma sulla Sostanza.