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Template:Isda 2(a)(iii) summ: Difference between revisions
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=== Assets, and flawed assets === | === Assets, and flawed assets === | ||
What is the big deal about this, then? Well, it turns your ISDA into a “flawed asset”. | What is the big deal about this, then? Well, it turns your ISDA into a “flawed asset”. | ||
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An asset that doesn’t have that quality of continuity: that suddenly isn’t there, or that has the unnerving quality of winking in and out of sight at inopportune moments — is thus somehow imperfect: “flawed”. | An asset that doesn’t have that quality of continuity: that suddenly isn’t there, or that has the unnerving quality of winking in and out of sight at inopportune moments — is thus somehow imperfect: “flawed”. | ||
Section | Section {{{{{1}}}|2(a)(iii)}} seems to have that effect on a {{{{{1}}}|Defaulting Party}}’s claims under an ISDA — its asset. Just when the {{{{{1}}}|Defaulting Party}} goes insolvent or fails to perform, the {{{{{1}}}|Non-defaulting Party}} is entitled to suspend the performance of its obligations without terminating the {{{{{1}}}|Transaction}}. Not entitled, even — as we will see, it just happens. | ||
Should the | Should the {{{{{1}}}|Defaulting Party}} then cure the default, the {{{{{1}}}|Transaction}} resumes and the {{{{{1}}}|Non-defaulting Party}} must resume all its obligations, including the suspended ones. But for so long as the default is not cured, the {{{{{1}}}|Non-defaulting Party}} does not have to do anything. The {{{{{1}}}|Defaulting Party}} is left hanging there, with this “flawed asset”. | ||
=== Insolvency regimes: not keen. === | === Insolvency regimes: not keen. === | ||
{{drop|T|he United States}} [[Bankruptcy Code]] renders unenforceable terms terminating or modifying a contract that are triggered by the simple fact of insolvency proceedings. These are known as “[[ipso facto]]” clauses, because the simple ''fact'' of bankruptcy “in itself” triggers the clause. | {{drop|T|he United States}} [[Bankruptcy Code]] renders unenforceable terms terminating or modifying a contract that are triggered by the simple fact of insolvency proceedings. These are known as “[[ipso facto]]” clauses, because the simple ''fact'' of bankruptcy “in itself” triggers the clause. | ||
If Section | If Section {{{{{1}}}|2(a)(iii)}} were an ipso facto clause, it would not be enforceable. Whether it ''is'' an [[ipso facto clause]] is a subject of vigorous but tiresome debate. For our purposes, that people don’t easily agree about it is all you need to know. | ||
The UK has no statutory equivalent of America’s [[ipso facto rule]], but hundreds of years ago resourceful common law judges “discovered” an “anti‑deprivation” rule to the effect that, in the honeyed words of Sir William Page Wood V.C., in ''Whitmore v Mason'' (1861) 2J&H 204:{{quote| | The UK has no statutory equivalent of America’s [[ipso facto rule]], but hundreds of years ago resourceful common law judges “discovered” an “anti‑deprivation” rule to the effect that, in the honeyed words of Sir William Page Wood V.C., in ''Whitmore v Mason'' (1861) 2J&H 204:{{quote| | ||
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This required some wilfulness on the bankrupt’s part and not just inadvertence or lucky hap, but still: if you set out to defeat the standing bankruptcy laws do not expect easily to get away with it. | This required some wilfulness on the bankrupt’s part and not just inadvertence or lucky hap, but still: if you set out to defeat the standing bankruptcy laws do not expect easily to get away with it. | ||
It seems, at any rate, that Section | It seems, at any rate, that Section {{{{{1}}}|2(a)(iii)}}, ''might'' resemble some kind of intended deprivation; merely crystallising one’s existing position and stopping it from going further down the Swanee, as one might do by closing out altogether, seems less likely to. | ||
Anyway: be aware: Section | Anyway: be aware: Section {{{{{1}}}|2(a)(iii)}} attracts insolvency lawyers. | ||
=== Rationale: avoiding a cleft stick === | === Rationale: avoiding a cleft stick === | ||
{{drop|W|e can have}} a fine time rabbiting away about the ontology of assets, but isn’t there a more basic question: why would a | {{drop|W|e can have}} a fine time rabbiting away about the ontology of assets, but isn’t there a more basic question: why would a {{{{{1}}}|Non-defaulting Party}}, presented with a counterparty in default, ever ''not'' want to just close out? | ||
It all comes down to [[Moneyness|''moneyness'']]. | It all comes down to [[Moneyness|''moneyness'']]. | ||
The “[[The bilaterality, or not, of the ISDA|bilaterality]]” of a swap transaction means that either party may, net, be “[[out of the money]]” — that is, it would have to ''pay'' a net sum of money were the Transaction terminated — at any time. Unless something dramatic happens, this “moneyness” is only a “notional” debt: it only becomes “due” if an | The “[[The bilaterality, or not, of the ISDA|bilaterality]]” of a swap transaction means that either party may, net, be “[[out of the money]]” — that is, it would have to ''pay'' a net sum of money were the Transaction terminated — at any time. Unless something dramatic happens, this “moneyness” is only a “notional” debt: it only becomes “due” if an {{{{{1}}}|Early Termination Date}} is designated under the Master Agreement. | ||
So an [[out-of-the-money]], | So an [[out-of-the-money]], {{{{{1}}}|Non-defaulting Party}} has a good reason ''not'' to close out the ISDA. Doing so would oblige it to crystallise and pay out a mark-to-market loss. Why should it have to do that just because a {{{{{1}}}|Defaulting Party}} has failed to perform its end of the bargain? | ||
On the other hand, the Defaulting Party is, er, ''ipso facto'', not holding up its end of the bargain. Just as our innocent Non-defaulting Party does not wish to realise a loss by terminating, nor does it want to have to stoically pay good money away to a Defaulting Party who isn’t paying anything back. | On the other hand, the Defaulting Party is, er, ''ipso facto'', not holding up its end of the bargain. Just as our innocent Non-defaulting Party does not wish to realise a loss by terminating, nor does it want to have to stoically pay good money away to a Defaulting Party who isn’t paying anything back. | ||
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A cleft stick, therefore. | A cleft stick, therefore. | ||
Section 2(a)(iii) allows our | Section {{{{{1}}}|2(a)(iii)}} allows our {{{{{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 — thereby neither crystallising its ugly [[mark-to-market]] position nor pouring perfectly good money away (which is a form of drip-feeding away that mark-to-market position, if you think about it). | ||
So much so good for the Non-defaulting Party. | So much so good for the {{{{{1}}}|Non-defaulting Party}}. | ||
But the | But the {{{{{1}}}|Defaulting Party}}’s “asset” — its contingent claim for its in-the-money position against the {{{{{1}}}|Non-defaulting Party}} — is compromised. This, for an insolvency administrator and all the {{{{{1}}}|Defaulting Party}}’s other creditors, is a bummer. It deprives them of the “asset” represented by the {{{{{1}}}|Transaction}}. | ||
===Which events?=== | ===Which events?=== | ||
{{drop|E|xactly ''which'' default}} events can trigger the suspension? Under the [[ISDA Master Agreement|ISDA]], | {{drop|E|xactly ''which'' default}} events can trigger the suspension? Under the [[ISDA Master Agreement|ISDA]], {{{{{1}}}|Events of Default}} and even ''Potential'' Events of Default do, but {{{{{1}}}|Termination Events}} and {{{{{1}}}|Additional Termination Event}} do not. This is because ''most'' {{{{{1}}}|Termination Events}} are softer, “Hey look, it’s no one’s fault, it’s just one of those things” kind of events. This is not usually true of {{{{{1}}}|Additional Termination Events}}, though: they tend to be credit-driven, and girded with more “culpability” and “event-of-defaulty-ness”. So this is a bit dissonant, but there are far greater dissonances, so we park this one and carry on. | ||
[[JC]] has seen valiant efforts to insert {{{{{1}}}|Additional Termination Events}} to section {{{{{1}}}|2(a)(iii)}}, and ''Potential'' {{{{{1}}}|Additional Termination Event}}, a class of things that does not exist outside the laboratory, and must therefore be defined. All this for the joy of invoking a clause that is highly unlikely to ever come into play, and which makes little sense in the first place. | |||
—[[Otto Büchstein]], [[Die Schweizer Heulsuse|''Die Schweizer Heulsuse'']] | ===Why the ISDA?=== | ||
{{quote| | |||
{{script|Herculio}}: All well-meant, good [[Triago]]. Be not sour —<br>These are not grapes.<br> | |||
{{script|Triago}}: Indeed not sir: rather, scrapes.<br>And scars and knocks — the job-lot doggedly sustained.<br> | |||
{{script|Herculio}}: (''Aside'') Some more than others. The odd one feigned.<br> | |||
But come, Sir Tig: what unrests you here?<br> | |||
{{script|Triago}} (''waving paper''): A tract from a brother clerk in America.<br> | |||
{{script|Herculio}}: Cripes abroad. Grim tidings?<br> | |||
{{script|Triago}}: Forsooth: it wears the colours of a fight.<br> | |||
A word-scape stain’d with tightly kernèd face<br> | |||
And girded round with fontish weaponry.<br> | |||
{{script|Herculio}} (''inspecting the document''): Verily, convenantry this dark<br> | |||
Speaks of litiginous untrust.<br> | |||
—[[Otto Büchstein]], [[Die Schweizer Heulsuse|''Die Schweizer Heulsuse'']]}}Why, then, is this flawed assets business special to ISDA? ''Is'' it special to ISDA? | |||
Normal financing contracts are, by nature, one-sided. Loans, for example. 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. | Normal financing contracts are, by nature, one-sided. Loans, for example. 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. | ||
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===Developments between editions=== | ===Developments between editions=== | ||
====“...a condition precedent for the purpose of this Section 2(a)(iii) ...”==== | ====“...a condition precedent for the purpose of this Section 2(a)(iii) ...”==== | ||
The {{2002ma}} trims back the third limb of Section 2(a)(iii) from “all other conditions precedent” to just those that specifically say they mean to be caught by Section {{ | The {{2002ma}} trims back the third limb of Section {{{{{1}}}|2(a)(iii)}} from “all other conditions precedent” to just those that specifically say they mean to be caught by Section {{{{{1}}}|2(a)(iii)}}. This a sensible restriction in scope as far as it goes (but JC would go further and remove Section 2(a)(iii) altogether). | ||
We have heard the argument advanced — apparently on the authority of that [[FT book about derivatives]] — that this restricted third limb somehow conditions the other conditions precedent in the clause (i.e., that there is no ongoing PEOD or EOD and that the Transaction has not already been terminated): | We have heard the argument advanced — apparently on the authority of that [[FT book about derivatives]] — that this restricted third limb somehow conditions the other conditions precedent in the clause (i.e., that there is no ongoing PEOD or EOD and that the Transaction has not already been terminated): | ||