Market Disruption Event - Equity Derivatives Provision
2002 ISDA Equity Derivatives Definitions
Section 6.3(a) in full
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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.
What counts as “Market Disruption”?
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
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.
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.
- Determining which are the “Exchanges” and “Related Exchanges” is ordinarily straightforward as they are specified in the confirmation.
- However, where “All Exchanges” is specified as the “Related Exchange”, then the Market Disruption Event may be triggered if there is a disruption on any exchange where trading has a material effect (as determined by Calculation Agent) on the overall market for futures or options relating to the underlier.
For details freaks
- (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.
- Disrupted Day, being a day on which a Market Disruption Event has occurred.
- Consequences of Disrupted Days;
- Trading Disruption under 6.3(b);
- Related Exchange;
- Exchange Disruption under 6.3(c);
- Early Closure under 6.3(d).