Market Disruption Event - Equity Derivatives Provision

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2002 ISDA Equity Derivatives Definitions
A Jolly Contrarian owner’s manual

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Resources About the Equity Derivatives Definitions | (full wikitext) | (nutshell wikitext)
Hot topics Synthetic Prime Brokerage Anatomy | The Triple Cocktail | Cancellation and Payment | Calculation Agent
TOC | 1 General Definitions | 2 Option Transactions | 3 Exercise of Options | 4 Forward Transactions | 5 Equity Swap Transactions | 6 Valuation | 7 Settlement | 8 Cash Settlement | 9 Physical Settlement | 10 Dividends | 11 Adjustments and Modifications | 12 Extraordinary Events · 12.8 Cancellation Amount · 12.9 Additional Disruption Events · 12.9 List of ADEs · 12.9(b) Consequences of ADEs | 13 Miscellaneous

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Section 6.3(a) in a Nutshell
Use at your own risk, campers!

6.3(a)Market Disruption Event” means

(i) a material Trading Disruption or Exchange Disruption to a Share or Index during the hour before the Valuation Time (etc), or
(ii) an Early Closure.

To work out whether there is a Market Disruption Event on an Index due to a Market Disruption Event on one of its component securities, the Calculation Agent will determine the percentage that security contributes to the Index by comparing

(x) how much of the Index level is attributable to that security with
(y) the Index level just before the Market Disruption Event happened.

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Full text of Section 6.3(a)

6.3(a) Market Disruption Event. “Market Disruption Event” means in respect of a Share or an Index, the occurrence or existence of:
(i) a Trading Disruption,
(ii) an Exchange Disruption, which in either case the Calculation Agent determines is material, at any time during the one hour period that ends at the relevant Valuation Time, Latest Exercise Time, Knock-in Valuation Time or Knock-out Valuation Time, as the case may be, or
(iii) an Early Closure.
For the purposes of determining whether a Market Disruption Event in respect of an Index exists at any time, if a Market Disruption Event occurs in respect of a security included in the Index at any time, then the relevant percentage contribution of that security to the level of the Index shall be based on a comparison of (x) the portion of the level of the Index attributable to that security and (y) the overall level of the Index, in each case immediately before the occurrence of such Market Disruption Event.

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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 fall in the Valuation chapter of the 2002 ISDA Equity Derivatives Definitions, not the Extraodinary Events. So that should tell you these are disruptions that get in the Calculation Agent’s hair and make valuing the trade harder — annoying, sure, but not so gnarly that the Hedging Party can’t comfortably hedge its exposure, so there’s no need to reprice the Transaction, or call on time on it altogether. To be sure, that time might come — especially if the Market Disruption is prolonged — but as long as you are in the Valuation chapter, the presumption is that it hasn’t come just yet.

If it does, make directly for the Extraordinary Events section (Section 12), and especially the Triple Cocktail.
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Summary


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General discussion

Indices

In the case of an Index, the disruption needs to affect 20% of more of the securities comprising the Index for the Index to be treated as disrupted. In that case valuation is moved for the whole index, not just the disrupted part.

Baskets

In the case of Baskets where some underliers are disrupted and some aren’t, only the affected underliers are subject to disruption provisions and the undisrupted aspects settle/value as scheduled.

Exchange and Related Exchange

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For details freaks

VWAP adjustments to Final Price for US Shares

Where share Final Price is determined by reference to the Volume Weighted Average Price during a trading session you may see this following amendment:

(a) Section 6.3(a) is amended by deleting “at any time during the one hour period that ends at the relevant Valuation Time, Latest Exercise Time, Knock-in Valuation Time or Knock-out Valuation Time, as the case may be” and replacing it with “at any time during the regular trading session on the Exchange, without regard to after hours or any other trading outside of the regular trading session hours”.
(b) Section 6.3(d) is amended by deleting the remainder of the provision following the term “Scheduled Closing Time” in the fourth line thereof;
(c) If the final Valuation Date is a Disrupted Day, the Calculation Agent may determine that such day is a Disrupted Day only in part, in which case the Calculation Agent must designate the Valuation Date determined pursuant to Section 6.6(a) for the remaining portion and the Calculation Agent must adjust the Number of Shares for which the Disrupted Day is the Valuation Date and must determine the Final Price based on such adjustments which will be based on such factors as the Calculation Agent considers relevant.

The current US tax interpretation is that benchmarking an equity swap on a US Share to the close is viewed a cross (and one is guilty until proven innocent). Therefore, do not use the official closing price for US Shares at maturity as it would then invalidate them as true derivatives and recharacterise them as repos. Instead, confirm VWAP over the day as an observable benchmark price for termination.

This does not, however, prevent one early-terminating an Equity Swap Transaction on a US Share using methods other than VWAP. Now, if you are a synthetic prime brokerage sort of camper, you might wonder why all this fuss as equity swaps are treated, for most purposes, as undated and are always terminated at the client’s motion as an optional early termination.
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See also

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References