Method for Determining Obligations - Credit Derivatives Provision

2014 ISDA Credit Derivatives Definitions A Jolly Contrarian owner’s manual™ 3.13 in a Nutshell™ The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack. You can even ask questions! Ask about it here. 3.13 in all its glory Section 3.13 Method for Determining Obligations. For purposes of Section 3.1(a) (Obligation), the term “Obligation” may be defined as each obligation of the Reference Entity described by the Obligation Category specified in the related Confirmation and having each of the Obligation Characteristics, if any, specified in the related Confirmation, in each case, immediately prior to the Credit Event which is the subject of either the Credit Event Notice or the DC Credit Event Question resulting in the occurrence of the Credit Event Resolution Request Date, as applicable. The following terms shall have the following meanings: (a) “Obligation Category” means Payment, Borrowed Money, Reference Obligation Only, Bond, Loan, or Bond or Loan, only one of which shall be specified in the related Confirmation, and: (i) “Payment” means any obligation (whether present or future, contingent or otherwise) for the payment or repayment of money, including, without limitation, Borrowed Money; (ii) “Borrowed Money” means any obligation (excluding an obligation under a revolving credit arrangement for which there are no outstanding, unpaid drawings in respect of principal) for the payment or repayment of borrowed money (which term shall include, without limitation, deposits and reimbursement obligations arising from drawings pursuant to letters of credit); (iii) “Reference Obligation Only” means any obligation that is a Reference Obligation and no Obligation Characteristics shall be applicable to Reference Obligation Only; (iv) “Bond” means any obligation of a type included in the “Borrowed Money” Obligation Category that is in the form of, or represented by, a bond, note (other than notes delivered pursuant to Loans), certificated debt security or other debt security and shall not include any other type of Borrowed Money; (v) “Loan” means any obligation of a type included in the “Borrowed Money” Obligation Category that is documented by a term loan agreement, revolving loan agreement or other similar credit agreement and shall not include any other type of Borrowed Money; and (vi) “Bond or Loan” means any obligation that is either a Bond or a Loan. (b) “Obligation Characteristics” means any one or more of Not Subordinated, Specified Currency, Not Sovereign Lender, Not Domestic Currency, Not Domestic Law, Listed and Not Domestic Issuance, and: (i) (A) “Not Subordinated” means an obligation that is not Subordinated to (I) the Reference Obligation or (II) the Prior Reference Obligation, if applicable; 3.13(b)(i)(B) “Subordination” means, with respect to an obligation (the “Second Obligation”) and another obligation of the Reference Entity to which such obligation is being compared (the “First Obligation”), a contractual, trust or similar arrangement providing that (I) upon the liquidation, dissolution, reorganization or winding-up of the Reference Entity, claims of the holders of the First Obligation are required to be satisfied prior to the claims of the holders of the Subordinated Second Obligation , or (II) the holders of the Second Obligation will not be entitled to receive or retain principal payments in respect of their claims against the Reference Entity at any time that the Reference Entity is in payment arrears or is otherwise in default under the First Obligation. “Subordinated” will be construed accordingly. For purposes of determining whether Subordination exists or whether an obligation is Subordinated with respect to another obligation to which it is being compared, (x) the existence of preferred creditors arising by operation of law or of collateral, credit support or other credit enhancement or security arrangements shall not be taken into account, except that, notwithstanding the foregoing, priorities arising by operation of law shall be taken into account where the Reference Entity is a Sovereign and (y) in the case of the Reference Obligation or the Prior Reference Obligation, as applicable, the ranking in priority of payment shall be determined as of the date as of which it was issued or incurred (or in circumstances where the Reference Obligation or a Prior Reference Obligation is the Standard Reference Obligation and “Standard Reference Obligation” is applicable, then the priority of payment of the Reference Obligation or the Prior Reference Obligation, as applicable, shall be determined as of the date of selection) and, in each case, shall not reflect any change to such ranking in priority of payment after such date; and (C) “Prior Reference Obligation” means, in circumstances where there is no Reference Obligation applicable to a Credit Derivative Transaction, (I) the Reference Obligation most recently applicable thereto, if any, and otherwise, (II) the obligation specified in the related Confirmation as the Reference Obligation , if any, if such Reference Obligation was redeemed on or prior to the Trade Date and otherwise, (III) any unsubordinated Borrowed Money obligation of the Reference Entity; (ii) “Specified Currency” means an obligation that is payable in the currency or currencies specified as such in the related Confirmation (or, if “Specified Currency” is specified in a Confirmation and no currency is so specified, any Standard Specified Currency), provided that if the euro is a Specified Currency, “Specified Currency” shall also include an obligation that was previously payable in the euro, regardless of any redenomination thereafter if such redenomination occurred as a result of action taken by a Governmental Authority of a Member State of the European Union which is of general application in the jurisdiction of such Governmental Authority; (iii) “Not Sovereign Lender” means any obligation that is not primarily owed to (A) a Sovereign or (B) any entity or organization established by treaty or other arrangement between two or more Sovereigns including, without limiting the foregoing, the International Monetary Fund, European Central Bank, International Bank for Reconstruction and Development and European Bank for Reconstruction and Development, which shall include, without limitation, obligations generally referred to as “Paris Club debt”; (iv) “Not Domestic Currency” means any obligation that is payable in any currency other than the applicable Domestic Currency, provided that a Standard Specified Currency shall not constitute a Domestic Currency; (v) “Not Domestic Law” means any obligation that is not governed by the applicable Domestic Law, provided that the laws of England and the laws of the State of New York shall not constitute a Domestic Law; (vi) “Listed” means an obligation that is quoted, listed or ordinarily purchased and sold on an exchange; and (vii) “Not Domestic Issuance” means any obligation other than an obligation that was issued (or reissued, as the case may be), or intended to be offered for sale primarily in the domestic market of the Reference Entity. Any obligation that is registered or, as a result of some other action having been taken for such purpose, is qualified for sale outside the domestic market of the Reference Entity (regardless of whether such obligation is also registered or qualified for sale within the domestic market of the Reference Entity) shall be deemed not to be issued (or reissued, as the case may be), or intended to be offered for sale primarily in the domestic market of the Reference Entity. edit Resources and Navigation Resources (full wikitext) | (nutshell wikitext) | Anatomy | Narrowly-tailored credit event | Equity v credit derivatives showdown Index: Click ᐅ to expand: Credit Derivatives Premium version of this page

Overview

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You may arrive at this page and begin to wonder if ISDA’s crack drafting squad™ has not gone over the front shovels of its skis here. Indeed, as you delve deeper into the forests of words, it is hard to escape the feeling the squad itself wonders if it has gone over its skis. Skiers will know there is a point of “send” where what’s done is done, you are airborne, there is nothing you can really do to stop yourself, and you might as well enjoy the few seconds of weightlessness before you land in a heap.

Summary

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You get to specify one Obligation Category and any number of Obligation Characteristics. Fear not, though: the Obligation Categories are rather like nested Russian dolls: each smaller one fits in the one before.

Obligation Categories

So Payment is about as wide as a payment obligation can be, and includes the Reference Entities day-to-day outgoings: rent, wages, utilities, even the paper bill, if you can find enough unpaid invoices to tot up to the Default Requirement.

Borrowed Money requires some kind of indebtedness — much discussion can be had about what is and is not indebtedness under the Cross Default page. (This is something ISDA ninjas delight in fiddler with. They really shouldn’t). But in CDS land it is actually “money you gave someone, apropos nothing beyond the clear idea they might one day give it back.

Inside Borrowed Money there are the two classic kinds of indebtedness: Loans — generally private, not easily transferable, bilateral credit arrangements (or mildly multilateral — if there is a syndicate), and Bonds — generally public, freely transferable, exchange-traded debt securities. Here you can choose one, the other, or both.

Obligation Characteristics

You can choose many of these, though some are mutually exclusive: Not Subordinated versus Subordinated being the obvious example.

The JC’s view is that if you are going to engage with credit derivatives, make them Not Subordinated. CDS is a troublesome enough asset class where it does work, superficially. It really doesn’t make sense for a capital note.

Prior Reference Obligation

There is a cheeky nod here to the Successor cluster bomb in the shape of the Prior Reference Obligation. Just what mischief ISDA’s crack drafting squad™ thought it was heading off is not clear — surely the answer is to make sure your Standard Reference Obligation table is up to date, not writing Heath Robinson machines prescribing what to do if it is not.

For really, what guide to the real world is a Reference Obligation that once existed, but now does not? Whatever may have since happened, that obligation paid itself off. What happened of successor Reference Obligations have materially different terms, tenors, and default triggers?

We may be about to find out. A DC question has been posed in exactly these terms in the fallout from the write -down of Lucky’s AT1 bonds. The Reference Obligation was indeed a Prior Reference Obligation\Aaa that had matured a couple of years ago.

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• The JC’s famous Nutshell™ summary of this clause

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See also

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