Physical Settlement - 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 9 in a Nutshell
Use at your own risk, campers!

Article 9 Physical Settlement
9.1. Physical Settlement of Option Transactions. For each Exercise Date under a Physically-settled Option Transaction, on the Settlement Date:

(a) Calls:
Buyer will pay Seller Settlement Price x Number of Shares to be Delivered or Settlement Price x Number of Baskets to be Delivered (without regard to rounding) and
Seller will deliver the Number of Shares to be Delivered or Number of Baskets to be Delivered and will pay any Fractional Share Amount to Buyer;
(b) Puts:
Buyer will deliver the Number of Shares to be Delivered or the Number of Baskets to be Delivered, and pay any Fractional Share Amount to Seller and
Seller will pay to Buyer Settlement Price x Number of Shares to be Delivered or Settlement Price x Number of Baskets to be Delivered (without regard to rounding); and
(c) such payments and deliveries will be made on the Settlement Date through the Clearance System to the accounts specified in the Confirmation.

9.2. Physical Settlement of Forward Transactions. For a Settlement Date under a Forward Transaction for which “Physical Settlement” applies, on the relevant Settlement Date:

(a) For a Share Forward Transaction:
(i) Neither “Prepayment” or “Variable Obligation” applies:
Buyer will pay to Seller an amount equal to Forward Price x Number of Shares, and
Seller will deliver the Number of Shares to be Delivered and pay any Fractional Share Amount to Buyer;
(ii) “Prepayment” does not apply and “Variable Obligation” applies:
Buyer will pay to Seller Forward Floor Price x Number of Shares
Seller will deliver the Number of Shares to be Delivered and pay any Fractional Share Amount to Buyer; and
(iii) if “Prepayment” applies, Seller will deliver to Buyer the Number of Shares to be Delivered and will pay the Excess Dividend Amount, if any, and any Fractional Share Amount; and
(b) For a Share Basket Forward Transaction:
(i) Neither “Prepayment” or “Variable Obligation” applies:
Buyer will pay to Seller an amount equal to Forward Price x Number of Baskets, and
Seller will deliver to Buyer Number of Shares of each Issuer in the Basket x Number of Baskets to be Delivered (rounded per Section 9.6) and will pay any Fractional Share Amount to Buyer;
(ii) “Prepayment” does not apply and “Variable Obligation” applies:
Buyer will pay to Seller Forward Floor Price x Number of Baskets' and'
Seller will deliver to Buyer Number of Shares of each Issuer in the Basket x Number of Baskets to be Delivered (rounded per Section 9.6) and will pay any Fractional Share Amount to Buyer; and
(iii) if “Prepayment” applies for each Issuer comprising the Basket, Seller will deliver to Buyer Number of Shares x Number of Baskets to be Delivered (rounded per Section 9.6) and will pay any Excess Dividend Amount or Fractional Share Amount to Buyer.

All payments and deliveries will be made through the Clearance Systems to the specified accounts of the Buyer or the Seller.
9.3. Physical Settlement of Equity Swap Transactions. Where “Physical Settlement” applies to an Equity Swap Transaction, on each Settlement Date:

9.4. “Settlement Date” means:

(a) for Option Transactions, the first Clearance System Business Day one Settlement Cycle after the Exercise Date; and
(b) for Forward Transactions and Equity Swap Transactions, the specified date (or, failing that, one Settlement Cycle after the Valuation Date (adjusted for Clearance System Business Days).
HOWEVER the Settlement Date will be delayed until any Settlement Disruption Event has lifted. If it doesn’t lift for 8 straight Clearance System Business Days then, if the Shares can be delivered some other way, the Settlement Date will be a settlement cycle after that eighth Clearance System Business Day. Otherwise, it will just be postponed until delivery can be effected.
If only some Shares in a Basket are disrupted, the unaffected portion must be settled on schedule.

9.5. “Number of Shares to be Delivered” is calculated as follows:

(a) Share Option Transactions: For an Exercise Date, number of exercised Options x Option Entitlement;
(b) Share Forward Transactions where “Variable Obligation” does not apply: the Number of Shares;
(c) Share Forward Transactions where “Variable Obligation” applies:
(i) if Settlement PriceForward Floor Price: Number of Shares.
(ii) if Forward Floor Price < Settlement PriceForward Cap Price: (Foward Floor Price/Equity Derivatives) x Number of Shares; and
(iii) if Settlement Price > Forward Cap Price: ((Forward Floor Price + Settlement Price - Forward Cap Price)/Settlement Price) x Number of Shares
(d) Share Swap Transactions: Number of Shares.
If the Number of Shares to be Delivered comprises any fraction of a Share, it will be rounded down to an integral number of Shares and a Fractional Share Amount will be payable in lieu of the fraction.

9.6. “Number of Baskets to be Delivered” means:

(a) Share Basket Option Transactions: on an Exercise Date, number of exercised Options x Option Entitlement.
(b) Share Basket Forward Transaction where “Variable Obligation” does not apply: Number of Baskets.
(c) Share Basket Forward Transaction where “Variable Obligation” applies:
(i) where Settlement PriceForward Floor Price: Number of Baskets.
(ii) where Forward Floor Price < Settlement PriceForward Cap Price: (Forward Floor Price/Settlement Price) x Number of Baskets.
(iii) where Settlement Price > Forward Cap Price: ((Forward Floor Price + Settlement Price - Forward Cap Price)/Settlement Price) x Number of Baskets
(d) Share Basket Swap Transactions: the Number of Baskets.
If the aggregate number of Shares of any Issuer in a Basket is not an integral number of Shares then the aggregate number of Shares of that Issuer to be delivered will be rounded down and a Fractional Share Amount paid in lieu of the fraction.

9.7. “Fractional Share Amount” means a Settlement Currency amount representing any fractional Share in a Number of Shares to be Delivered or the Number of Baskets to be Delivered multiplied by:

(a) Share Option Transactions and Share Basket Option Transactions: the Settlement Price for that Share on the Exercise Date (assuming Cash Settlement with an Exercise Date of the Valuation Date);
(b) Share Forward Transactions and Share Basket Forward Transactions: the Settlement Price for that Share on the Valuation Date for that Settlement Date (or, if none, the date one Settlement Cycle before the Settlement Date); and
(c) Share Swap Transactions and Share Basket Swap Transactions: the Final Price for the Share on the Valuation Date for that Settlement Date (or, if none, the date one Settlement Cycle before the Settlement Date).

9.8. “Settlement Disruption Event” means, an event beyond the control of the parties which means the Clearance System cannot transfer a Share.
9.9. Expenses. All Share transfer expenses and taxes will be payable by the party that would pay them in a normal sale of the Sharess in question through the relevant Clearance System.
9.10. Delivery Versus Payment. Delivery versus payment will apply wherever delivery and payment are due on the same day and the Clearance System permits it.
9.11. Representation and Agreement. A party delivering Shares under a Transaction represents, on the date of conveyance, that it has conveyed good title to the necessary Shares, free from:

(i) Encumbrance: any encumbrance (other customary liens) or other restrictions, without the receiver having to provide any documents or comply with any volume or manner of sale restrictions,
(ii) Transfer restrictions: any restrictions or required consents to transfer of the Shares by any person,
(iii) Transferee limitations: any limitations on who may be transferred such Shares,
(iv) Certification requirements: Any approval, consent, opinion or notice from any person before transfer, and
(v) Registration: any registration, qualification or prospectus delivery requirement for such Shares under applicable laws.
(vi) Book-entry form: Where a Clearance System is involved, the Shares are properly in book-entry form.

9.12. Indemnification for Failure to Deliver. If, absent a designatged Early Termination Date, a party fails to perform any delivery obligation, it will indemnify the other party on demand for any costs or expenses the other party incurs as a result. The deliveree’s signed certificate giving reasonable detail of those costs or expenses will be conclusive evidence that they have been incurred. However, no party will be liable for Consequential loss in any circumstances.
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Full text of Section 9

Article 9 Physical Settlement
Section 9.1. Physical Settlement of Option Transactions. In respect of each Exercise Date under an Option Transaction for which “Physical Settlement” is applicable, on the relevant Settlement Date:

(a) in the case of a Call, Buyer will pay to Seller the Settlement Price multiplied by the Number of Shares to be Delivered or the Number of Baskets to be Delivered, as the case may be, (in either case determined without regard to rounding) and Seller will deliver to Buyer the Number of Shares to be Delivered or the Number of Baskets to be Delivered, as the case may be, and will pay to Buyer the Fractional Share Amount, if any;
(b) in the case of a Put, Buyer will deliver to Seller the Number of Shares to be Delivered or the Number of Baskets to be Delivered, as the case may be, and will pay to Seller the Fractional Share Amount, if any, and Seller will pay to Buyer the Settlement Price multiplied by the Number of Shares to be Delivered or the Number of Baskets to be Delivered, as the case may be (in either case determined without regard to rounding); and
(c) such payment and such delivery will be made on the relevant Settlement Date through the relevant Clearance System(s) at the accounts specified in the related Confirmation.

Section 9.2. Physical Settlement of Forward Transactions. In respect of a Settlement Date under a Forward Transaction for which “Physical Settlement” is applicable, on the relevant Settlement Date:

(a) in respect of a Share Forward Transaction:
(i) if “Prepayment” is not applicable and “Variable Obligation” is not applicable, then Buyer will pay to Seller an amount equal to the Forward Price multiplied by the Number of Shares, and Seller will deliver to Buyer the Number of Shares to be Delivered and will pay to Buyer the Fractional Share Amount, if any;
(ii) if “Prepayment” is not applicable and “Variable Obligation” is applicable, then Buyer will pay to Seller an amount equal to the Forward Floor Price multiplied by the Number of Shares, and Seller will deliver to Buyer the Number of Shares to be Delivered and will pay to Buyer the Fractional Share Amount, if any; and
(iii) if “Prepayment” is applicable, then Seller will deliver to Buyer the Number of Shares to be Delivered and will pay to Buyer the Excess Dividend Amount, if any, and the Fractional Share Amount, if any; and
(b) in respect of a Share Basket Forward Transaction:
(i) if “Prepayment” is not applicable and “Variable Obligation” is not applicable, then Buyer will pay to Seller an amount equal to the Forward Price multiplied by the Number of Baskets, and, in respect of each Issuer comprising the Basket, Seller will deliver to Buyer the Number of Shares of such Issuer multiplied by the Number of Baskets to be Delivered (rounded as provided in Section 9.6) and will pay to Buyer the Fractional Share Amount, if any;
(ii) if “Prepayment” is not applicable and “Variable Obligation” is applicable, then Buyer will pay to Seller an amount equal to the Forward Floor Price multiplied by the Number of Baskets, and, in respect of each Issuer comprising the Basket, Seller will deliver to Buyer the Number of Shares of such Issuer multiplied by the Number of Baskets to be Delivered (rounded as provided in Section 9.6) and will pay to Buyer the Fractional Share Amount, if any; and
(iii) if “Prepayment” is applicable, then, in respect of each Issuer comprising the Basket, Seller will deliver to Buyer the Number of Shares of such Issuer multiplied by the Number of Baskets to be Delivered (rounded as provided in Section 9.6) and will pay to Buyer the Excess Dividend Amount, if any, and the Fractional Share Amount, if any.

Any such payment and/or such delivery will be made through the relevant Clearance System(s) to the accounts of the Buyer or the Seller, as the case may be, specified in the related Confirmation.
Section 9.3. Physical Settlement of Equity Swap Transactions. In respect of each Settlement Date for an Equity Amount Payer under an Equity Swap Transaction for which “Physical Settlement” is applicable, on the relevant Settlement Date the Equity Amount Payer will deliver to the Equity Amount Receiver the Number of Shares to be Delivered or the Number of Baskets to be Delivered, as the case may be, and will pay to the Equity Amount Receiver the Fractional Share Amount, if any, and the Equity Amount Receiver will pay to the Equity Amount Payer the Equity Notional Amount. Such payment and such delivery will be made on the relevant Settlement Date through the relevant Clearance System(s) at the accounts specified in the related Confirmation.
Section 9.4. Settlement Date. “Settlement Date” means

(a) in respect of Shares to be delivered in respect of an Exercise Date under an Option Transaction, the date that falls one Settlement Cycle following that Exercise Date (or, if such date is not a Clearance System Business Day, the next following Clearance System Business Day), and
(b) in respect of Shares to be delivered under a Forward Transaction or an Equity Swap Transaction, the date specified as such in the related Confirmation or if none is specified, the date that falls one Settlement Cycle following the Valuation Date (or, if such date is not a Clearance System Business Day, the next following Clearance System Business Day), in each case unless a Settlement Disruption Event prevents delivery of such Shares on that date.

If a Settlement Disruption Event does prevent delivery on that date, then the Settlement Date will be the first succeeding date on which delivery of the Shares can take place through the relevant Clearance System unless a Settlement Disruption Event prevents settlement on each of the eight relevant Clearance System Business Days immediately following the original date that, but for the Settlement Disruption Event, would have been the Settlement Date. In that case,

(x) if such Shares can be delivered in any other commercially reasonable manner, then the Settlement Date will be the first date on which settlement of a sale of Shares executed on that eighth relevant Clearance System Business Day customarily would take place using such other commercially reasonable manner of delivery (which other manner of delivery will be deemed the relevant Clearance System for the purposes of delivery of the relevant Shares), and
(y) if such Shares cannot be delivered in any other commercially reasonable manner, then the Settlement Date will be postponed until delivery can be effected through the relevant Clearance System or in any other commercially reasonable manner.

In the case of a Share Basket Transaction, if as a result of a Settlement Disruption Event some but not all of the Shares comprised in a Basket are affected, the Settlement Date for Shares not affected by the Settlement Disruption Event will be the original Settlement Date and the Settlement Date for the Shares that are affected by the Settlement Disruption Event shall be determined as provided above. In the event that a Settlement Disruption Event will result in the delivery on a Settlement Date of some but not all of the Shares comprised in a Basket, the Calculation Agent shall determine in its discretion the appropriate pro rata portion of the amount payable to be paid by the relevant party in respect of that partial settlement.
Section 9.5. “Number of Shares to be Delivered”. “Number of Shares to be Delivered” means the number of Shares calculated as set out below:

(a) in respect of an Exercise Date under a Share Option Transaction, a number of Shares equal to the number of Options exercised or deemed exercised on that Exercise Date multiplied by the Option Entitlement;
(b) under a Share Forward Transaction for which “Variable Obligation” is not applicable, the Number of Shares;
(c) under a Share Forward Transaction for which “Variable Obligation” is applicable:
(i) if the Settlement Price is less than or equal to the Forward Floor Price, the Number of Shares;
(ii) if the Settlement Price is greater than the Forward Floor Price but less than or equal to the Forward Cap Price, a number of Shares equal to:
(Foward Floor Price/Equity Derivatives) x Number of Shares; and
(iii) if the Settlement Price is greater than the Forward Cap Price, a number of Shares equal to:
((Forward Floor Price + Settlement Price - Forward Cap Price)/Settlement Price) x Number of Shares
(d) under a Share Swap Transaction, the Number of Shares.
In the event that the number of Shares calculated as set out above comprises any fractional Share, the Number of Shares to be Delivered will include only whole Shares and a Fractional Share Amount will be payable by the relevant party in lieu of such fractional Share.

Section 9.6. “Number of Baskets to be Delivered”. “Number of Baskets to be Delivered” means:

(a) in respect of an Exercise Date under a Share Basket Option Transaction, the number of Baskets equal to the number of Options exercised or deemed exercised on that Exercise Date multiplied by the Option Entitlement;
(b) under a Share Basket Forward Transaction for which “Variable Obligation” is not applicable, the Number of Baskets;
(c) under a Share Basket Forward Transaction for which “Variable Obligation” is applicable:
(i) if the Settlement Price is less than or equal to the Forward Floor Price, the Number of Baskets;
(ii) if the Settlement Price is greater than the Forward Floor Price but less than or equal to the Forward Cap Price, a number of Baskets equal to:
(Forward Floor Price/Settlement Price) x Number of Baskets; and
(iii) if the Settlement Price is greater than the Forward Cap Price, a number of Baskets equal to:
((Forward Floor Price + Settlement Price - Forward Cap Price)/Settlement Price) x Number of Baskets
(d) under a Share Basket Swap Transaction, the Number of Baskets.
In respect of an Issuer comprising the Basket, if the aggregate number of Shares of such Issuer calculated by multiplying the relevant Number of Shares by the Number of Baskets to be Delivered comprises a fractional Share, then the aggregate number of Shares of such Issuer that is delivered will include only whole Shares and a Fractional Share Amount will be payable by the relevant party in lieu of such fractional Share.

Section 9.7. Fractional Share Amount. “Fractional Share Amount” means an amount in the Settlement Currency representing the fractional Share resulting from the calculation of the Number of Shares to be Delivered or the Number of Baskets to be Delivered in respect of a Transaction as determined by the Calculation Agent multiplied by:

(a) in respect of a Share Option Transaction or a Share Basket Option Transaction, the Settlement Price attributable to the relevant Share on the Exercise Date (determined assuming Cash Settlement were applicable and the Exercise Date were the Valuation Date);
(b) in respect of a Share Forward Transaction or a Share Basket Forward Transaction, the Settlement Price attributable to the relevant Share on the Valuation Date related to the relevant Settlement Date (or, if there is no such Valuation Date, the date that is one Settlement Cycle prior to the relevant Settlement Date); and
(c) in respect of a Share Swap Transaction or a Share Basket Swap Transaction, the Final Price attributable to the relevant Share on the Valuation Date related to the relevant Settlement Date (or, if there is no such Valuation Date, the date that is one Settlement Cycle prior to the relevant Settlement Date).

Section 9.8. Settlement Disruption Event. “Settlement Disruption Event” means, in respect of a Share, an event beyond the control of the parties as a result of which the relevant Clearance System cannot clear the transfer of such Share.
Section 9.9. Expenses. All expenses relating to the transfer of Shares to be delivered under a Transaction (such as any stamp duty, stock exchange tax or local tax) will be payable by the party that would pay such expenses according to market practice for a sale of such Shares under such Transaction to be settled through the relevant Clearance System in one Settlement Cycle.
Section 9.10. Delivery Versus Payment. In respect of any Settlement Date on which there is a corresponding payment obligation, if the relevant Clearance System permits settlement to occur on a delivery versus payment basis, then settlement shall occur on such basis.
Section 9.11. Representation and Agreement. A party required to deliver Shares under a Transaction agrees that it will convey, and, on any date that it delivers such Shares, represents that it has conveyed, good title to the Shares it is required to deliver, free from

(i) any lien, charge, claim or other encumbrance (other than a lien routinely imposed on all securities by the relevant Clearance System) and any other restrictions whatsoever, including any restrictions under applicable securities laws, without any obligation on the part of the receiver of such Shares in connection with that party’s subsequent sale of such Shares to deliver an offering document, or comply with any volume or manner of sale restrictions,
(ii) any and all restrictions that any sale, assignment or other transfer of such Shares be consented to or approved by any person or entity, including without limitation, the Issuer or any other obligor thereon,
(iii) any limitations on the type or status, financial or otherwise, of any purchaser, pledgee, assignee or transferee of such Shares,
(iv) any requirement of the delivery of any certificate, approval, consent, agreement, opinion of counsel, notice or any other document of any person or entity to the Issuer of, any other obligor on or any registrar or transfer agent for, such Shares, prior to the sale, pledge, assignment or other transfer of such Shares, and
(v) any registration or qualification requirement or prospectus delivery requirement for such Shares pursuant to applicable securities laws. A party required to deliver Shares under a Transaction also represents that to the extent appropriate for the relevant Clearance System, the Shares are properly in book-entry form.

Section 9.12. Indemnification for Failure to Deliver. If, in respect of any obligation to deliver Shares under a Transaction, prior to the occurrence or effective designation of an Early Termination Date in respect of that Transaction, a party fails to perform any obligation required to be settled by delivery, it will indemnify the other party on demand for any costs, losses or expenses (including the costs of borrowing the relevant Shares, if applicable) resulting from such failure. A certificate signed by the deliveree setting out such costs, losses or expenses in reasonable detail will be conclusive evidence that they have been incurred. Notwithstanding the foregoing, unless the parties otherwise agree to the contrary expressly and in writing in the related Confirmation, a party shall not be responsible for any special, indirect or consequential damages, even if informed of the possibility thereof.
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Content and comparisons

Article 9. Physical Settlement

Section 9.1. Physical Settlement of Option Transactions
Section 9.2. Physical Settlement of Forward Transactions
Section 9.3. Physical Settlement of Equity Swap Transactions
Section 9.4. Settlement Date
Section 9.5. Number of Shares to be Delivered
Section 9.6. Number of Baskets to be Delivered
Section 9.7. Fractional Share Amount
Section 9.8. Settlement Disruption Event
Section 9.9. Expenses
Section 9.10. Delivery Versus Payment
Section 9.11. Representation and Agreement
Section 9.12. Indemnification for Failure to Deliver

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Summary

Not enormously common, since the whole point of an equity derivative is to have price exposure without ever taking title to the Shares, with all the attendant tax, disclosures, mandatory take-over obligations and other miscellaneous regulatory hair that comes from physically owning shares that it would imply, but for you exotic types who might want to do this — especially those trading Forwards, Options — being contracts to maybe acquired Shares at a later date and not necessarily pure synthetic plays — here they are. The JC’s specialty bing synthetic equity swaps, this isn’t something that we have spent a lot of time on, but as we read them, the provisions are largely mechanical and while ISDA’s crack drafting squad™’s prose as a quality to it only Heath Robinson’s mother could love, when you boil it down, as we have done in our nutshell versions (see panel), they do make sense in a “that figures, I guess” or “that really ought to go without saying” kind of way.

So sorry for not having a lot to say, but here: knock yourself out.

Settlement Date

The Settlement Date is relevant for physical settlement of securities. Where cash is concerned, the droid you are looking for is the Cash Settlement Payment Date. Obviously a physical settlement is more fraught with risk of failures through disruption, exchange suspensions, illiquidity etc, whereas for the most part cash is cash and you just pay it.

Representation and Agreement

You get the sense that ISDA’s crack drafting squad™ had significant deal fatigue by this stage — reading this mush, I know I do — but it seems some of the representations and agreements required here are not things that a transferor can reasonably do anything about, let alone represent to, being out of its control and a function of the nature of the Shares underlying the Transaction. Now, true, to be eligible for clearing in a Clearance System, Shares generally need to be largely free of these kinds of consents, conditions precedent and restrictions on transfer — but if for some reason they are not, what is the poor receiver supposed to do about it, why is it in any better position to make this rep than the deliveror, and what good will the representation be in any case?

Indemnity

The Indemnity in Section 9.12 broadly replicates the buy-in costs regime in stock lending (see for example Failure by either Party to deliver in the 2010 GMSLA. Note the “certificate being conclusive evidence” is meant to undermine the tendency courts have to overturn the scope of gratuitously wide indemnities: the restriction on consequential loss and
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See also

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References