Set-off - ISDA Provision
2002 ISDA Master Agreement
Section 6(f) in full
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ISDA published a suggested set-off provision in the Users Guide but no-one liked it, and several bespoke versions developed and percolated around the market. These often provided for the inclusion of Affiliates in relation to the Non-defaulting Party or Non-affected Party.
ISDA’s crack drafting squadTM got the hint and implemented a fully-fledged set-off provision based on this language into the 2002 ISDA — but not without a little boo-boo. You can read all about it, and the boo-boo, and what people have done to fix it, at our article about that Section 6(f) Set-off provision.
One does not exercise a set-off right willy nilly. Unless one is, mutually, settlement netting (where on a given day I owe you a sum, you owe me a sum, and we agree to settle by one of us paying the other the difference) set-off is a drastic remedy which will be seen as enemy action. You would not do it, without agreement, to any client you expected to keep. So, generally, use set-off as a remedy it only arises following an event of default. See, for example, Set-off in the 2002 ISDA under Section 6(f). So you don’t just do it for the hell of it.
A bit of a bish in the 2002 ISDA
Set-off in the 2002 ISDA borrows from the text used to build it into the 1992 ISDA (see below) but still contains a rather elementary fluff. It imagines a world where the Early Termination Amount is payable one way, while all Other Amounts are only payable the other. Life, as any fule kno, is not always quite that convenient.
- Payer owes Payee an Early Termination Amount of 10
- Payer owes Payee Other Amounts of 40
- Payee owes Payer Other Amounts of 50
Not ideal. But fixable if you’re prepared to add some dramatically anal language:
- 6(f) Set-Off. Any Early Termination Amount (or any other amounts, whether or not arising under this Agreement, matured, contingent and irrespective of the currency, place of payment of booking of the obligation)” payable to one party (the “Payee”) by the other party (the “Payer”), ...
The 2002 ISDA’s Set-off provision refers to a “Payer” and “Payee”. Since either the “Payer” or the “Payee” could be the Innocent Party, including Affiliates into the 2002 definition becomes problematic and cumbersome.
Generally, market practice is therefore to do the following:
- Where Affiliates are required: to use bespoke wording.
- Where Affiliates are not required: use the 2002 ISDA standard set-off wording above.
But cross affiliate set-off is a pretty rum affair in any case. Generally, set-off requires mutuality of payment, currency, time and counterparty, so setting off between affiliates is liable to challenge anyway (unless you have cross-guarantee arrangements). And in these modern days of bank recovery and resolution, conjoining claims between entities which are supposed to be siloed and independent isn’t really the thing.
Scope of Set-off
The 2002 ISDA set-off wording allows set-off following an Event of Default, CEUM, or any other Termination Event where there is one Affected Party and all outstanding transactions are Affected Transactions.
Often brokers will also want to set-off where there is an Illegality or ATE. There is no specific reference to all Transactions being Affected Transactions but this is implied in any set-off provision by its nature:
- If only some transactions are Affected Transactions and so only a portion of outstanding Transactions are being terminated then there is an on-going relationship and unilateral set-off is not appropriate.
- i.e., if you weren’t terminating all Transactions, it would be drastic and counterproductive to a relationship to use a set-off.
- As such, the Tax Event and Tax Event Upon Merger provisions (those not caught by your wording) are more likely to only affect certain transactions and not all Transactions and therefore set-off is not likely to be relevant in such instances.
- Force Majeure: The 1992 ISDA contains no Force Majeure provision. Commercially, it is not likely that an ISDA Master Agreement would be closed-out as a result of a Termination Event as these are generally viewed as non-fault and set-off would generally not be relevant.
- Illegality does allow either party to terminate but this is limited to all Affected Transactions which may not result in a close-out of the entire ISDA Master Agreement. In fact, the definition used of Affected Transactions makes it clear that in the cases of Illegality, Tax Event Upon Merger or Tax Event then it will only be transactions affected by the Termination Event that are closed-out. In relation to ATEs and CEUM this will be all Transactions and so set-off is relevant.