Additional Disruption Event definitions - Equity Derivatives Provision

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2002 ISDA Equity Derivatives Definitions
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Section 12.9(a) in a Nutshell™

Use at your own risk, campers!
12.9(a) Additional Disruption Event definitions: The following terms are defined as follows:
12.9(a)(i) “Additional Disruption Event” means any of the events in paragraphs 12.9(a)(ii) to 12.9(a)(viii):
12.9(a)(ii) “Change in Law” means either party determines that, due to a change in law or regulation:
(X) it becomes illegal to buy, sell or hold underlying Shares or;
(Y) it becomes materially more expensive to perform the Transaction.
12.9(a)(iii) “Failure to Deliver” means a party’s failure to deliver Shares when due under a Transaction because of market illiquidity;
12.9(a)(iv) “Insolvency Filing” means that the Issuer commences or agrees to insolvency proceedings or a winding-up petition (or has one instituted against it by a regulator or insolvency administrator). Non-consensual insolvency action taken by creditors is not an Insolvency Filing;
12.9(a)(v) “Hedging Disruption” means that the Hedging Party cannot reasonably acquire, hold, replace or unwind any transactions hedging its equity price risk, or realise, recover or pay the proceeds of any hedging transactions.
12.9(a)(vi) “Increased Cost of Hedging” means that the Hedging Party would incur a materially increased cost under the Transaction to:
(A) hedge its equity price risk; or
(B) realise the proceeds of its hedge.
This excludes costs arising solely from the deterioration of its own creditworthiness.
12.9(a)(vii) “Loss of Stock Borrow” means that, having used commercially reasonable efforts, the Hedging Party cannot borrow the Shares it needs to hedge the Transaction at a rate equal to or lower than the Maximum Stock Loan Rate;
12.9(a)(viii) “Increased Cost of Stock Borrow”: the rate the Hedging Party incurs to borrow Shares for the Transaction exceeds the Initial Stock Loan Rate;
12.9(a)(ix) “Hedging Party”: The party specified as such in the Confirmation or, if none, either party;
12.9(a)(x) “Hedging Shares” means the number of Shares the Hedging Party needs to hedge the equity price risk under a Transaction;
12.9(a)(xi) “Lending Party” means a counterparty that the Hedging Party reasonably and in good faith selects;
12.9(a)(xii) “Non-Hedging Party” is not the Hedging Party;
12.9(a)(xiii) “Maximum Stock Loan Rate” for any “Loss of Stock Borrow” will be specified in the Confirmation;
12.9(a)(xiv) “Initial Stock Loan Rate” for any Increased Cost of Stock Borrow will be specified in the Confirmation; and
12.9(a)(xv) “Price Adjustment” means an adjustment to a price, spread or other variable in a Transaction.

Full text of Section 12.9(a)

12.9(a) Each of the following terms shall have the meaning set forth below:
12.9(a)(i) “Additional Disruption Event” means any of the events set forth in paragraphs 12.9(a)(ii) through 12.9(a)(viii) below:
12.9(a)(ii) “Change in Law” means that, on or after the Trade Date of any Transaction:
(A) due to the adoption of or any change in any applicable law or regulation (including, without limitation, any tax law), or
(B) due to the promulgation of or any change in the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law or regulation (including any action taken by a taxing authority),
a party to such Transaction determines in good faith that:
(X) it has become illegal to hold, acquire or dispose of Shares relating to such Transaction, or
(Y) it will incur a materially increased cost in performing its obligations under such Transaction (including, without limitation, due to any increase in tax liability, decrease in tax benefit or other adverse effect on its tax position);
12.9(a)(iii) “Failure to Deliver” means the failure of a party to deliver, when due, the relevant Shares under that Transaction, where such failure to deliver is due to illiquidity in the market for such Shares;
12.9(a)(iv) “Insolvency Filing” means that the Issuer institutes or has instituted against it by a regulator, supervisor or any similar official with primary insolvency, rehabilitative or regulatory jurisdiction over it in the jurisdiction of its incorporation or organization or the jurisdiction of its head or home office, or it consents to a proceeding seeking a judgment of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights, or a petition is presented for its winding-up or liquidation by it or such regulator, supervisor or similar official or it consents to such a petition, provided that proceedings instituted or petitions presented by creditors and not consented to by the Issuer shall not be deemed an Insolvency Filing;
12.9(a)(v) “Hedging Disruption” means that the Hedging Party is unable, after using commercially reasonable efforts, to (A) acquire, establish, re-establish, substitute, maintain, unwind or dispose of any transaction(s) or asset(s) it deems necessary to hedge the equity price risk of entering into and performing its obligations with respect to the relevant Transaction, or (B) realize, recover or remit the proceeds of any such transaction(s) or asset(s);
12.9(a)(vi) “Increased Cost of Hedging” means that the Hedging Party would incur a materially increased (as compared with circumstances existing on the Trade Date) amount of tax, duty, expense or fee (other than brokerage commissions) to (A) acquire, establish, re-establish, substitute, maintain, unwind or dispose of any transaction(s) or asset(s) it deems necessary to hedge the equity price risk of entering into and performing its obligations with respect to the relevant Transaction, or (B) realize, recover or remit the proceeds of any such transaction(s) or asset(s), provided that any such materially increased amount that is incurred solely due to the deterioration of the creditworthiness of the Hedging Party shall not be deemed an Increased Cost of Hedging;
12.9(a)(vii) “Loss of Stock Borrow” means that the Hedging Party is unable, after using commercially reasonable efforts, to borrow (or maintain a borrowing of) Shares with respect to such Transaction in an amount equal to the Hedging Shares (not to exceed the number of Shares underlying the Transaction) at a rate equal to or less than the Maximum Stock Loan Rate;
12.9(a)(viii) “Increased Cost of Stock Borrow” means that the Hedging Party would incur a rate to borrow Shares in respect of such Transaction that is greater than the Initial Stock Loan Rate;
12.9(a)(ix) “Hedging Party” means the party specified in the related Confirmation as the Hedging Party or, if no Hedging Party is specified, either party to the Transaction;
12.9(a)(x) “Hedging Shares” means the number of Shares that the Hedging Party deems necessary to hedge the equity price risk of entering into and performing its obligations with respect to a Transaction to which “Loss of Stock Borrow” or “Increased Cost of Stock Borrow” is applicable;
12.9(a)(xi) “Lending Party” means a third party that the Hedging Party considers to be a satisfactory counterparty (acting in good faith and in a commercially reasonable manner in light of other transactions that the Hedging Party may have entered into with such party);
12.9(a)(xii) “Non-Hedging Party” means the party that is not the Hedging Party;
12.9(a)(xiii) “Maximum Stock Loan Rate” means, in respect of a Transaction to which “Loss of Stock Borrow” is applicable, the stock loan rate specified as such in the related Confirmation;
12.9(a)(xiv) “Initial Stock Loan Rate” means, in respect of a Transaction to which “Increased Cost of Stock Borrow” is applicable, the stock loan rate specified as such in the related Confirmation; and
12.9(a)(xv) “Price Adjustment” means an adjustment to the Strike Price, Initial Price, Forward Price, Forward Floor Price, Forward Cap Price, Knock-in Price, Knock-out Price, spread or other variable with respect to the relevant Transaction.


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Content and comparisons

Section 12.9(a): The actual Additional Disruption Events

12.9(a)(i) Additional Disruption Event
12.9(a)(ii) Change in Law
12.9(a)(iii) Failure to Deliver
12.9(a)(iv) Insolvency Filing
12.9(a)(v) Hedging Disruption
12.9(a)(vi) Increased Cost of Hedging
12.9(a)(vii) Loss of Stock Borrow
12.9(a)(viii) Increased Cost of Stock Borrow

Section 12.9(a): Other definitions relating to Additional Disruption Events

12.9(a)(ix) Hedging Party
12.9(a)(x) Hedging Shares
12.9(a)(xi) Lending Party
12.9(a)(xii) Non-Hedging Party
12.9(a)(xiii) Maximum Stock Loan Rate
12.9(a)(xiv) Initial Stock Loan Rate
12.9(a)(xv) Price Adjustment

To follow what’s going on you’ll need to understand the Consequences of an Additional Disruption Event, which is set out at Section 12.9(b).

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Summary

Break these “Extraordinary Events” into four categories:

Section-by-section

Sections 12.9(a)(vii) and 12.9(a)(iv) Loss of Stock Borrow

Loss of Stock Borrow is an Additional Disruption Event in the 2002 ISDA Equity Derivatives Definitions, and is fondly abbreviated, by this commentator at least, to LOSB. It pairs nicely with an Increased Cost of Stock Borrow, fish or chicken. See also 12.9(b)(vii) which deals with the tension between LOSB and Hedging Disruption.

Loss of Stock Borrow under Synthetic PB: For synthetic prime brokerage, it is common for the PB to pass on its stock borrowing costs (well: it is a synthetic equivalent of a stock borrow and a short sale, after all, so this makes sense). It does this by subtracting the prevailing borrow rate from the floating rate it pays under the swap. Therefore the Non-Hedging Party wears the ultimate cost of the expensive stock borrow, so there’s no real need to impose a Maximum Stock Loan Rate (though prime brokers will typically impose one as a matter of course).
Comparing Loss of Stock Borrow and Increased Cost of Stock Borrow: There is a logical hand-off and interaction between Loss of Stock Borrow with Increased Cost of Stock Borrow:

Section 12.9(a)(ix) Hedging Party

The conceptual confusion caused by physical hedging not being done by the counterparty in person. And don’t even start about the Determining Party

Relevant in the context of Additional Disruption Events and hedging disruption, the Hedging Party will be the entity actually carrying out the hedging activity, if it isn’t the party to the ISDA Master Agreement itself. If no Hedging Party is specified, it defaults to the parties themselves.

Note also the related concept of the Determining Party, who is the person calculating the replacement cost of the Transaction following an Extraordinary Event (e.g. termination following a Hedging Disruption, Change in Law or Increased Cost of Hedging).

In this case there will be a string of intermediate hedging contracts — usually derivatives — but these may not behave in exactly the way that a real underlier would (in terms of market disruption, tax events, liquidity etc). and what the Equity Derivatives Definitions are meant to do is pass on the risk associated with the actual underlier.

So for example in the example pictured, Party A provide exposure to client, hedges that with a equity TRS to Hedging Party, which goes long the physical share. Now the Hedging Party, not Party A, has the risk of the physical assets. If there is a market disruption, or a tax event on the physical hedge this is reflected in the price that Hedging Party will have to pay to Party A, but it isn’t a market disruption or tax event directly on Party A itself (and in fact might not be – Party A might be domiciled in a jurisdiction benefitting from a different tax treaty with the jurisdiction of the underlier, for example). So in this case we need to reference the position as held by a person other than the counterparty to the swap.

Note also that “Non-Hedging Party” definition somewhat assumes that the Hedging Party will indeed be the actual counterparty to the Transaction.

Section 12.9(a)(xii) Non-Hedging Party

Not hugely controversial, you would think, but it does sort of imply that the Hedging Party is itself a party to the transaction - otherwise both parties are Non-Hedging Parties. But if so, then there's not really any need for the definition of Hedging Party at all ...

Section 12.9(a)(xiii) Maximum Stock Loan Rate

Relevant only where Increased Cost of Stock Borrow or Loss of Stock Borrow apply to a Transaction. (You will know because there will be a "Maximum Stock Loan Rate" specified in the Confirmation).

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See also

Template:M sa Equity Derivatives 12.9(a)

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References

  1. ↑ especially since there is already an “Insolvency” event covering most of this).
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