Parental guarantee
|
Banking basics
A recap of a few things you’d think financial professionals ought to know
|
A parental guarantee is a guarantee from a parent, which could be an actual parent — the bank of mum and dad, guaranteeing junior’s student loan — but for our purposes, more likely another credit-worthy affiliate in the same group, often the one that owns all or most of the equity in the party being guaranteed. Often your counterparty will be a financing subsidiary, created as a separate, thinly capitalised vehicle within the group for accounting, financial reporting and liability limitation purposes.
A parental guarantee means that, should things go toes-up on your $500m revolving credit facility, you have more to go at than a bunch of papers in the Cayman Islands with a share capital of ten bucks and a registered address at Ugland House.
Guarantees and the ISDA Master Agreement: why Transaction-specific guarantees don’t work
Should a client request a transaction-specific parental guarantee (or letter of credit) for a Transaction under an ISDA Master Agreement instead of the usual “all obligations” guarantee of all the counterparty’s obligations under the ISDA Master Agreement, hit the alarm button.
You should never agree to the guarantee of individual Transactions (nor accept a letter of credit with respect to individual Transactions) under an ISDA Master Agreement. If you do, because of the way ISDA Master Agreements are closed out under Section 6(e) — or rather, aren’t closed out, you might find that just when you want your guarantee to pay, the Transaction it is guaranteeing isn’t there anymore:
On a close-out, each Transaction is terminated, the individual close-out amounts are determined, they’re aggregated up to a single net sum (i.e. negative exposures are netted off against positive ones) and a single Close Out Amount is payable with respect to all terminated Transactions under 6(e) (Payments on Early Termination) of the ISDA Master Agreement.[1]
That is to say, payments following termination of a Transaction are not payable under the Transaction at all - they are payable under the ISDA Master Agreement itself. Therefore, if the guarantee relates to the single Transaction, at the point you wish to rely on it (i.e., upon the party’s default), it will have gone, with no payment required. Vanished, like tears in the rain.
References
- ↑ The ISDA Master Agreement itself is never actually terminated, but carries impotently on in undead twilight, roaming the badlands like Nosferatu or the Flying Dutchman, unloved, unredeemed, until the end of days.