Market Disruption Events Generally - 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 in a Nutshell
Use at your own risk, campers!

6.3. General Terms Relating to Market Disruption Events
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.
6.3(b)Trading Disruption” means any suspension or limitation on trading imposed by an Exchange or Related Exchange for any reason
(i) relating to the Share on the Exchange (or on Exchanges for securities comprising at least 20 percent of the Index level, for any Index Transactions and Index Basket Transactions), or
(ii) in futures or options contracts on the Share or Index on any Related Exchange.
6.3(c) Exchange Disruption means any event (other than an Early Closure) that the Calculation Agent determines impedes market participants trading or valuing:
(i) Shares on an Exchange (or, for Index Transactions and Index Basket Transactions, on Exchanges whose securites comprise at least 20 percent of the Index level), or
(ii) futures or options contracts on the Share or the Index on any Related Exchange.

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Full text of Section 6.3

Section 6.3. General Terms Relating to Market Disruption Events.

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.
6.3(b) Trading Disruption. “Trading Disruption” means any suspension of or limitation imposed on trading by the relevant Exchange or Related Exchange or otherwise and whether by reason of movements in price exceeding limits permitted by the relevant Exchange or Related Exchange or otherwise
(i) relating to the Share on the Exchange (or in the case of an Index Transaction or Index Basket Transaction on any relevant Exchange(s) relating to securities that comprise 20 percent or more of the level of the relevant Index), or
(ii) in futures or options contracts relating to the Share or the relevant Index on any relevant Related Exchange.
6.3(c) Exchange Disruption. “Exchange Disruption” means any event (other than an Early Closure) that disrupts or impairs (as determined by the Calculation Agent) the ability of market participants in general
(i) to effect transactions in, or obtain market values for, the Shares on the Exchange (or in the case of an Index Transaction or Index Basket Transaction, on any relevant Exchange(s) in securities that comprise 20 percent or more of the level of the relevant Index), or
(ii) to effect transactions in, or obtain market values for, futures or options contracts relating to the Share or the relevant Index on any relevant Related Exchange.
6.3(d) Early Closure. “Early Closure” means the closure on any Exchange Business Day of the relevant Exchange (or in the case of an Index Transaction or Index Basket Transaction, any relevant Exchange(s) relating to securities that comprise 20 percent or more of the level of the relevant Index) or any Related Exchange(s) prior to its Scheduled Closing Time unless such earlier closing time is announced by such Exchange(s) or Related Exchange(s) at least one hour prior to the earlier of (i) the actual closing time for the regular trading session on such Exchange(s) or Related Exchange(s) on such Exchange Business Day and (ii) the submission deadline for orders to be entered into the Exchange or Related Exchange system for execution at the Valuation Time on such Exchange Business Day.

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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



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Summary

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:

Additionally a day is “Disrupted Day” if an Exchange/Related Exchange fails to open for trading during a regular trading session.
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General discussion

Market Disruption Events vs Additional Disruption Events showdown

In a Nutshell:

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.
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See also

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References