Nationalization, Insolvency and Delisting - 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

Index: Click to expand:

Section 12.6 in a Nutshell
Use at your own risk, campers!

12.6 Nationalization, Insolvency and Delisting
12.6(a) The following definitions apply:

(i) “Nationalization” means all an Issuer’s Shares or substantially all of its assets have to be transferred to a government;
(ii) “Insolvency” means that an Issuer becomes insolvent and:
(A) all its Shares have to be transferred to an insolvency administrator or
(B) Shareholders of that Issuer are prohibited from transferring them; and
(iii) “Delisting” means that the Exchange announces that the Shares will cease to be listed on the Exchange (except because of a Merger Event or Tender Offer) and are not immediately re-listed on another exchange in the same country (or, where the Exchange is in the European Union, in the European Union).

12.6(b) If either party becomes aware of a Nationalization, Insolvency or Delisting, it will promptly tell the other party.
12.6(c) When determining the consequence of any Nationalization, Insolvency or Delisting:

(i)if “Negotiated Close-out” applies, then unless the parties agree to terminate the Transaction it will continue, but either party may choose to cash settle a Physically-settled Transaction, and if a Scheduled Valuation Date is a Disrupted Day, the Calculation Agent will ignore Section 6.6 (Disrupted Days) and use its good faith estimate to determine the Settlement Price or Final Price as of the Valuation Time on that Valuation Date;
(ii) “Cancellation and Payment” means that the Transaction will be cancelled as of the Announcement Date and
(A) For Option Transactions, Seller will pay Buyer an amount calculated per Section 12.7(b);
(B) For Forward Transactions or Equity Swap Transactions, one party will pay the other an amount calculated per Section 12.7(c); and
(iii) “Partial Cancellation and Payment” means that the portion of a Share Basket Transaction representing Affected Shares will be cancelled as of the Announcement Date, the amount for the Affected Shares will be calculated and paid per Section 12.7 and the remainder of the Share Basket Transaction will continue with the non-Affected Shares, the Calculation Agent adjusting any terms as necessary to preserve as far as possible the economic terms for the remaining Share Basket.

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Full text of Section 12.6

12.6 Nationalization, Insolvency and Delisting
12.6(a) The following terms have the meanings given below:

(i) “Nationalization” means that all the Shares or all or substantially all the assets of an Issuer are nationalized, expropriated or are otherwise required to be transferred to any governmental agency, authority, entity or instrumentality thereof;
(ii) “Insolvency” means that by reason of the voluntary or involuntary liquidation, bankruptcy, insolvency, dissolution or winding-up of or any analogous proceeding affecting an Issuer, (A) all the Shares of that Issuer are required to be transferred to a trustee, liquidator or other similar official or (B) holders of the Shares of that Issuer become legally prohibited from transferring them; and
(iii) “Delisting” means that the Exchange announces that pursuant to the rules of such Exchange, the Shares cease (or will cease) to be listed, traded or publicly quoted on the Exchange for any reason (other than a Merger Event or Tender Offer) and are not immediately re-listed, re-traded or re-quoted on an exchange or quotation system located in the same country as the Exchange (or, where the Exchange is within the European Union, in any member state of the European Union).

12.6(b) Either party will, upon becoming aware of the occurrence of a Nationalization, Insolvency or Delisting, promptly notify the other party of such event.
12.6(c) For the purpose of determining the consequence of any Nationalization, Insolvency or Delisting:

(i) “Negotiated Close-out” means that the parties may, but are not obliged, to terminate the Transaction on mutually acceptable terms and if the parties do not agree to terminate the Transaction, then it continues on the terms and subject to the conditions then in effect, provided, that any Physically-settled Transaction will, at the election of either party, become a Transaction to which Cash Settlement is applicable, except that if a Scheduled Valuation Date is a Disrupted Day, the Calculation Agent will ignore the provisions of Section 6.6 relating to Disrupted Days and will instead determine its good faith estimate of the Settlement Price or Final Price as of the Valuation Time on that Valuation Date;
(ii) “Cancellation and Payment” means that the Transaction will be cancelled as of the Announcement Date and (A) in the case of an Option Transaction, Seller will pay to Buyer the amount calculated in accordance with Section 12.7(b), and (B) in the case of a Forward Transaction or an Equity Swap Transaction, an amount calculated in accordance with Section 12.7(c) will be paid by one party to the other; and
(iii) “Partial Cancellation and Payment” means that in respect of a Share Basket Transaction, that portion of the Share Basket Transaction represented by Affected Shares will be cancelled as of the Announcement Date, the amount calculated in accordance with Section 12.7 in respect of such Affected Shares, will be paid by one party to the other, the remainder of the Share Basket Transaction will continue with the Basket comprising Shares that are not Affected Shares, and the Calculation Agent will adjust any relevant terms if necessary to preserve as nearly as practicable the economic terms of the Transaction for the remaining Shares.

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Content and comparisons

Section 12.6. Nationalization, Insolvency and Delisting
Section 12.7. Payment upon Certain Extraordinary Events

12.7(a) (Cancellation and Payment; Partial Cancellation and Payment)
12.7(b) (Effect of Extraordinary Events on Option Transactions)
12.7(c) (Effect of Extraordinary Events on Forward Transactions and Equity Swap Transactions)

Section 12.8. Cancellation Amount

12.8(a)Cancellation Amount
12.8(b) “Means of determination”
12.8(c) “Determination”
12.8(d) “Quotations”
12.8(e) “Liquidation of hedges”
12.8(f)Determining Party
12.8(g)Commercially reasonable procedures

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Summary

If these particular Extraordinary Events (Nationalization, Insolvency and Delisting) occur, the parties may elect to terminate (if they choose Negotiated Close-out), or the transaction will automatically terminate (if Cancellation and Payment (Extraordinary Events) or Partial Cancellation and Payment (Extraordinary Events) are selected).

  • Cancellation and Payment means that on one of these Extraordinary Events occurring, the trade is terminated immediately and valued by the Calculation Agent or the Determining Party (important to check who this is!). This gives certainty and would be important in the case of a delta-1 derivative exposure with no defined termination (or where the defined termination is extremely long-dated).
  • Negotiated Close-out requires the parties to agree on the termination value, with a fall back to the trade continuing until the scheduled termination date, whereupon it would be valued by the Calculation Agent in good faith (and ignoring the Additional Disruption Event that otherwise would surely be alleged). Note that the trade will terminate, but not until scheduled termination, and in the absence of mutual agreement both parties are committed to the term, which may not make a great deal of sense where the underlyer has been subject to Insolvency, Nationalization or a similarly drastic Extraordinary Event.

Note that a Delisting covers full cessation of trading but not a suspension of trading, even if indefinite. But in that case a Hedging Disruption or - at a pinch - Increased Cost of Hedging ought to get you home.

Depositary receipts and hostile governmental action

Now imagine that rather than nationalizing, a national government announced some draconian law preventing corporations in its jurisdiction from accessing the international capital markets even through depositary receipt programmes — you know, something crazy like that.[1] So say, ooh: the DRs must be converted into underlying shares within a stipulated period, failing which the underlying shares lose their dividend and voting rights[2]

The common sense (and economically correct) answer is “however it shakes out, this is all the customer’s risk” — remember the synthetic equity mantra: this is just equity brokerage done with swaps. Imagine what would happen, dear customer, had your broker sold you the ADR outright, a year ago, and now it has been unwound by wartime governmental manoeuvre. Whose problem would that be? Not your equity broker’s, for sure.

That said, the 2002 ISDA Equity Derivatives Definitions don’t do a magnificent job of specifically dealing with what is undoubtedly an extremely far-fetched situation. For once, we should not be too exacting on ISDA’s crack drafting squad™. I mean, who ever heard of a government forcing local issuers to unwind their GDRs just to spite hostile foreign investors?

So, anyway, you are a swap dealer, everything is messy as hell, tanks are unexpectedly rolling across foreign lands somewhere, and now your customer is on the horn asking what the hell is going on. You, naturally, will be as accommodating and constructive as you can in looking for outcomes for your client in such devilish times, but would still like the peace of mind of knowing, should everything go titten hoch, you can cancel the swap and walk away, paying a nugatory Cancellation Amount based on the worthlessness of the underliers. How can you?

  • Isn’t a nationalization
  • Isn’t an insolvency
  • It isn’t *inherently* a delisting (though de facto almost certainly will be as the international (...er hostile?...) Exchanges will most likely delist the DRs, but they don’t have to)
  • It isn’t a Change in Law as that refers to laws impacting the counterparties to the trade, not the Issuer;
  • It isn’t an Increased Cost of Hedging. well — it just isn’t, is it?
  • It may be a Hedging Disruption – I mean it is hard to hedge an instrument that has just been compusorily dissolved, right? — though is disappearance of an instrument altogether so that there is nothing to replicate the return of at all really just a hedge disruption?

Also useful at least by way of analogy is “Tender Offer”. It’s not quite on point – but close, and perhaps useful by way of analogy should you have counterparties that are in denial about the fact that, from a very basic standpoint, they are the ones that are long local “craziest regulator in the room” risk, and not their long-suffering swap dealer.
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General discussion

For Insolvency, compare with the wider Insolvency Filing under Section 12.9(a)(iv), and the much wider Bankruptcy Event of Default in the ISDA Master Agreement.

You may be forgiven for wondering what the difference is between “Insolvency”, being the normal Extraordinary Event from Section 12.6, and the Additional Disruption Event called “Insolvency Filing”.

It’s a good question that, we dare say, even ISDA’s crack drafting squad™ would struggle to capably answer, but the reality is that this people tend to disapply Insolvency Filing, as it is covered by other Additional Disruption Events so Insolvency is the important one.
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See also

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References


  1. Attentive readers may wonder whether this is really a figment of the JC’s imagination, or something the Russian State Duma actually did, in April 2022.
  2. And therefore become largely worthless: they entitle a holder to a pro-rata share of the Issuer’s assets on a non-insolvent winding up or something like that — but who ever wound up a non-insolvent company?