Template:M gen 2002 ISDA 2(a)

Flawed assets

Section 2(a)(iii): Of these provisions, the one that generates the most controversy (chiefly among academics and scholars, it must be said) is Section 2(a)(iii). It generates a lot less debate between negotiators, precisely because its legal effect is nuanced, so its terms are more or less inviolate. Thus, should your counterparty take a pen to Section 2(a)(iii), a clinching argument against that inclination is “just don’t go there, girlfriend”.

Payments and deliveries

In a rare case of leaving things to practitioners’ common sense, ISDA’s crack drafting squad™ deigned not to say what it meant by “payment” or “delivery”.

Payments are straightforward enough, we suppose — especially since they are stipulated to be made in “freely transferable funds and in the manner customary for payments in the required currency”: beyond that, money being money, you either pay or you don’t: there are not too many shades of meaning left for legal eagles to snuggle into.

Deliveries, though, open up more scope for confecting doubts one can then set about avoiding. what does it mean to deliver? What of assets in which another actor might have some claim, title or colour of interest? In financing documents you might expect at least a representation that “the delivering party beneficially owns and has absolute rights to deliver any required assets free from any competing interests other than customary liens and those arising under security documents”.

What better cue could there be for opposing combatants leap into their trenches, and thrash out this kind of language?

Less patient types — like yours truly — might wish to read all of that into the still, small voice of calm of the word “deliver” in the first place. What else could it realistically mean, but to deliver outright, and free of competing claims? It is bound up with implications about what you are delivering, and whose the thing is that you are delivering. It would be absurd to suppose one could discharge a physical delivery obligation under a swap by “delivering” an item to which one had no title at all: it is surely implicit in the commercial rationale that one is transferring, outright, the value implicit in an asset and not just the formal husk of the asset itself, on terms that it may be whisked away at any moment. One is surrendering the implicit expense of the asset (in return for whatever your counterparty surrenders to you). As the bailiffs take leave of your counterparty with the asset you gave it strapped to their wagon, it would hardly do to say, “oh, well, I did deliver you that asset: it never said anywhere I had to have any proprietary interest in it, or that I was meant to be transferring any legal interest in it to you. It is all about my the act of delivery, I handed something to you, and that is that.” Delivery is more than performative.

We think one could read that into the question of whether a delivery has been made at all. Should a third party assert title to or some claim over the asset, the innocent party’s best tactic is not to look vainly for representations as to the terms of delivery, but to deny that delivery has taken place at all.

In any weather, much of this is bound up nowadays in the realities of how financial assets trade: that is electronically, fungibly, in book-entry systems, where securities are taken over accounts, by way of physical pledge, and the transfer of assets naturally comes electronically and without strings attached. It seems unlikely a security holder could mount a claim to recover an asset transferred electronically to a bona fide third party recipient for value without notice: the practicalities of its security interest lie in its control over the asset in the first place: holding it, or at the least being entitled to stop a third party security trustee or escrow custodian delivering away the asset without the security holder’s prior consent.