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The “[[The bilaterality, or not, of the ISDA|bilaterality]]” of most derivatives arrangements means that either party may, net, be “[[out of the money]]” — that is, across all outstanding transactions, it would have to ''pay'' a net sum of money if all transactions were terminated. This is a notional debt that only becomes “due” as such if you designate an {{{{{1}}}|Early Termination Date}} under the Master Agreement. So an [[out-of-the-money]] {{{{{1}}}|Non-defaulting Party}} has a good reason therefore ''not'' to close out the ISDA. Why should it have to pay out just because a {{{{{1}}}|Defaulting Party}} has failed to perform its end of the bargain? On the other hand, if it forebears from terminating against a bankrupt counterparty the {{{{{1}}}|Non-defaulting Party}} doesn’t want to have to continue stoically paying good money away to a bankrupt counterparty who isn’t reciprocating. | The “[[The bilaterality, or not, of the ISDA|bilaterality]]” of most derivatives arrangements means that either party may, net, be “[[out of the money]]” — that is, across all outstanding transactions, it would have to ''pay'' a net sum of money if all transactions were terminated. This is a notional debt that only becomes “due” as such if you designate an {{{{{1}}}|Early Termination Date}} under the Master Agreement. So an [[out-of-the-money]] {{{{{1}}}|Non-defaulting Party}} has a good reason therefore ''not'' to close out the ISDA. Why should it have to pay out just because a {{{{{1}}}|Defaulting Party}} has failed to perform its end of the bargain? On the other hand, if it forebears from terminating against a bankrupt counterparty the {{{{{1}}}|Non-defaulting Party}} doesn’t want to have to continue stoically paying good money away to a bankrupt counterparty who isn’t reciprocating. | ||
An [[out-of-the-money]] {{{{{1}}}|Non-defaulting Party}} seems, therefore, | An [[out-of-the-money]], {{{{{1}}}|Non-defaulting Party}} seems to be, therefore, in a bit of a cleft stick. | ||
Section 2(a)(iii) allows the {{{{{1}}}|Non-defaulting Party}} the best of both worlds. The [[conditions precedent]] to payment not being satisfied it can just stop performing, and sit on its hands | Section {{{{{1}}}|2(a)(iii)}} allows the {{{{{1}}}|Non-defaulting Party}} the best of both worlds. The [[conditions precedent]] to payment not being satisfied, it can just stop performing, and sit on its hands and thereby not thereby crystallise the [[mark-to-market]] loss implied by its [[out-of-the-money]] position. | ||
The {{{{{1}}}|Defaulting Party}}’s “asset” — its right to be paid, or delivered to under the {{{{{1}}}|Transaction}} — is “flawed” in the sense that its rights don’t apply for so long as ''the [[conditions precedent]] to payment are not fulfilled''. | |||
Conceivably you ''could'' invoke a flawed asset provision even if you were [[in-the-money]], but you would be mad to. | Conceivably you ''could'' invoke a flawed asset provision even if you were [[in-the-money]], but you would be mad to. | ||
====Which events?==== | |||
Exactly ''which'' default events can trigger a flawed asset clause will depend on the contract. Under the {{isdama}} | Exactly ''which'' default events can trigger a flawed asset clause will depend on the contract. Under the {{isdama}}, {{{{{1}}}|Events of Default}} and even ''Potential'' {{{{{1}}}|Events of Default}} do, but {{{{{1}}}|Termination Event}}s and {{{{{1}}}|Additional Termination Event}}s do not. {{{{{1}}}|Termination Event}}s are softer, “hey look, it’s no-one’s fault, it’s just one of those things” kind of closeouts, so that makes some sense — but on the other hand this is not really true of {{{{{1}}}|Additional Termination Event}}s, which tend to be credit-driven and with more “culpability” and “event-of-defaulty-ness” about them. This is, a bit dissonant, but there are far greater dissonances, so we park this one and carry on. | ||
=====2(a)(iii) in a time of Credit Support===== | =====2(a)(iii) in a time of Credit Support===== |