Exchanges, Clearing Systems and Currencies - Equity Derivatives Provision
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2002 ISDA Equity Derivatives Definitions A Jolly Contrarian owner’s manual™
Exchanges, Clearing Systems and Currencies in all its glory
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Overview
A JC-curated sub-division of the General Definitions section. We sub-group the Section 1 definitions into the following subgroups:
- Transactions — Sections 1.1 - 1.12
- Underliers — Sections 1.13 - 1.16
- Trade Details — Sections 1.17 - 1.24
- Exchanges, Clearing Systems and Currencies — Sections 1.25 - 1.37
- Trade Features — Sections 1.38 - 1.41
- Knock-ins and Knock-outs — Sections 1.42 - 1.51
These are the Exchanges, Clearing Systems and Currencies definitions:
1.25. Exchange
1.26. Related Exchange
1.27. Clearance System
1.28. Index Sponsor
1.29. Exchange Business Day
1.30. Scheduled Closing Time
1.31. Scheduled Trading Day
1.32. Currency Business Day
1.33. Settlement Currency
1.34. Euro
1.35. EC Treaty
1.36. Clearance System Business Day
1.37. Settlement Cycle
Summary
Section 1.25
Relevant to the definition of Market Disruption Event. Note also the related concept of the “Related Exchange” — a real ISDA definition, and Alternative Exchange, which is a JC fabrication we just made up because the “substitute or successor exchange offering comparable liquidity” language, which gets repeated a lot, is so tedious.
The JC’s definition if Alternative Echange - and remember this is fan fiction, okay? Not canonical — is:
An “Alternative Exchange”, in relation to any Exchange, is any successor or substitute exchange to which trading in the underlying Shares may have relocated (as long as the Calculation Agent is satisfied that it offers comparable liquidity)
The limbs are:
They are, mutatis mutandis, the same, only 1.25(a) talks about “Shares underlying the Index” which obviously isn’t needed when referring to Shares themselves.
Not to be confused, however tempting and, really, forgiveable it may be, with a Related Exchange under paragraph 1.26. A Related Exchange (real) is not the same as an Alternative Exchange (made up by the JC)
Section 1.26
Related Exchange is relevant to Market Disruption Event. See also the related definition at “Exchange”.
In each case, the relevant Related Exchange will be specified in the Confirmation — the standard tends to be “All Exchanges”), and these are exchanges on which “trading in futures or options contracts relating to such Index or such Share” takes place.
Section 1.26 could have done with clearer punctuation in our humble view, but our best guess is that you determine the Related Exchange as follows:
- each “Related Exchange” so specified in the Confirmation — this could be in theory be an options exchange or a stock exchange, but for reasons set out below, we think it is meant to only be a futures or options exchange;
- any successor to those specified Related Exchanges, (also could be either, but) or
- any substitute exchange to the above to which trading in futures or options on the Index/Share has temporarily relocated, unless
- the Confirm specifies “All Exchanges”, in which case “Related Exchange” means all exchange or quotation systems that material effect the overall market for futures or options on the Index/Share.
Now you tell me, but this looks like an attempt to limit “Related Exchanges” to options and futures exchanges, and leave stock exchanges to the definition of regular “Exchange”s. This is corroborated by the fact that Settlement Cycle, Settlement Price and Final Price which are relevant to delivering and valuing Shares, only references “Exchanges”, not “Related Exchanges”, and most of the references to Related Exchanges in the defintions relate to the pricing of forwards and options — In-the-Moneyness of Calls and Puts, Trading Disruptions on options and futures, and in the related definition of Options Exchange, which definitely is meant to be an, um, Options Exchange.
Then again, there is a definition of Options Exchange: what the necessary difference is between a Related Exchange and Options Exchange, we have not quite yet nutted out. Do write in if you have any ideas.
Section 1.27
The artist known to to ISDA’s crack drafting squad™ as a Clearance System but to the rest of the world as a clearing system, or if it breaks down, whatever the parties can figure out. But in that regard see Additional Disruption Events and Extraordinary Events.
Section 1.28
One who sponsors indices: the likes of Dow Jones, FTSE, Reuters, Eurostoxx, and for customised indices many of the banks and dealers.
Section 1.29
The sort of thing you would like to think did not need to be defined, enormously, but then there is what to do if the exchange closes unexpectedly halfway through its day — that is still an Exchange Business Day, but it may affect the Valuation Time. For much tedium in this regard do directly to the Disrupted Days and Valuation provisions of section 6 and the Physical Settlement provisions of Section 9.
Section 1.30
Scheduled Closing Time be like the scheduled “closing time”. We wonder what would happen if some kind of disintermediated, permissionless, always-on crypto-exchange with noscheduled closing time ever started — for trading NFTs of equities or something — but struggle to care, frankly.
Section 1.31
Relevance to Additional Disruption Events
Additional Disruption Events dans une Nutshell™
The important Additional Disruption Events are the Triple Cocktail: Change in Law, Hedging Disruption and Increased Cost of Hedging. They have marginally different play-out rights:
- Change in Law: Either party can terminate on 2 Scheduled Trading Day’s notice, at the Cancellation Amount.
- Hedging Disruption: Hedging Party can terminate on 2 Scheduled Trading Day’s notice, at the Cancellation Amount.
- Increased Cost of Hedging: Hedging Party can present the other guy with a proposed Price Adjustment. Other guy, within 2 Scheduled Trading Days, either accepts the Price Adjustment in an amended trade, pays the PV of the Price Adjustment in full, or the Hedging Party can terminate the trade on the second Scheduled Trading Day, at the Cancellation Amount.
Okay, okay, I hear you — LOSB and ICOSB are important too. For those:
- Loss of Stock Borrow: Hedging Party gives 2 Scheduled Trading Day’s notice of the LOSB. Other guy can either lend the shares itself at the Maximum Stock Loan Rate or lower, or if it doesn’t the Hedging Party can terminate the trade at the Cancellation Amount.
- Increased Cost of Stock Borrow: Hedging Party can present the other guy with a proposed Price Adjustment. Other guy, within 2 Scheduled Trading Days, either accepts the Price Adjustment in an amended trade, pays the PV of the Price Adjustment in full, or lend the Hedging Party the necessary Shares, Failing this, the Hedging Party can terminate the trade on the second Scheduled Trading Day, at the Cancellation Amount.
Insolvency Filing and Failure to Deliver ... well — are they even applied in your confirm?
Section 1.32
A business day in the principal financial centre for a currency. Well, I’d like to see you think of something interesting to say about this. Could ISDA’s crack drafting squad™ have left this undefined? We think so. Would they, in any possible universe? Unlikely.
Section 1.33
ET phone in.
Section 1.34 and 1.35
A bit of a historical artefact: At the time the ISDA’s crack drafting squad™ was labouring over the 2002 ISDA Equity Derivatives Definitions, the euro was a rather new fangled thing, and as such there are a number of provisions that have the air of skepticism about them that such a project could ever really work. After all, it is hard to see how a sovereign state could really control its fiscal policy without the levers of currency control and rate setting. But twenty years on, it all seems to have been a roaring success, so we needn’t have worried.
That said, there have been some wobbles, and given the succession of global disasters that have befallen us since that single stabilising force for the modern world, David Bowie, left us — you know, Brexit, the decline of America, global pandemic, hyperinflation, war in Europe — we should not be at all surprised if the Euro falls apart next, and may yet be grateful for the ’squad’s patient curlicues.
Section 1.36
A bit of deemery here: a day that is, or was meant to be, an ordinary clearing system business day even if, due to the vicissitudes of our nasty brutish and short modern life, no business is in fact done on that day.
Section 1.37
Handy concept for specifying the date on which an action must be effected such that settlement takes place on a given date: eg “The Final Price will be determined one Settlement Cycle prior to the Termination Date”. Note also Correction of Share Prices and Index Levels in Section 11.4.
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- The JC’s famous Nutshell™ summary of this clause