Template:Isda 2(a)(iii) summ: Difference between revisions

As we have remarked before, most financing contracts are decidedly one-sided. One party — the dealer, broker, bank: we lump these various financial service providers together as ''The Man'' — provides services, lends money and manufactures risk outcomes; the other — the customer — ''consumes'' them.  

Generally, the customer presents risks to The Man, and not vice versa. In a loan, all the “fontish weaponry” is pointed in the same direction: the customer’s. It goes without saying that should the customer “run out of road”, The Man stands to ''lose'' something. What is to be done should ''The Man'' run out of road is left undetermined but implicitly it is unlikely, and not expected to change anything for the customer. Whatever you owe, you will continue to owe; just to someone else.

Though the ISDA is also, in practice, a “risk creation contract” and has these same characteristics, it is not, in ''theory'', designed like one. ''Either'' party can be [[out-of-the-money]], and either party can blow up. The ISDA’s fontish weaponry points ''both ways''.

This presented dealers with an unusual scenario: what happens if ''you'' blow up when ''I'' owe you money? I might not want to crystallise my contract: that will involve me paying you a [[mark-to-market]] replacement cost I hadn’t budgeted for paying out just now. (This is less true in these days of mandatory [[variation margin]] — that is one of JC’s main objections — but the {{isdama}} was forged well before this modern era).

The ISDA answers this with the “[[flawed asset]]<nowiki>” provision of Section {{</nowiki>{{{1}}}<nowiki>|2(a)(iii)}}. This allows an innocent, but </nowiki>[[out-of-the-money]], party faced with its counterparty’s default, to not close out the ISDA, but just freeze its own obligations until the default situation is resolved.