Template:M gen Equity Derivatives 5.10

Example

Let’s say:

• a swap is struck with an initial Equity Notional Amount of £10m
• the swap is now out of the money to Party A by £1mm.
• Party A has therefore posted £1mm in collateral to Party B.

An Equity Notional Reset would operate as follows:

• The Equity Notional Amount would be reset at £9mm (the calculation being original Equity Notional Amount + Equity Amount, which in this case would be £10mm + £-1mm = £9mm)
• In consideration for this reduction in the Equity Notional Amount, Party A would become liable to pay an exchange amount of £1mm.
• at the same time Party B's exposure to Party B would be reduced to nil, meaning Party B would be oblished to return £1mm of equivalent credit support.
• The return of credit support would be netted off against the exchange amount due, meaning no cashflow would take place.

Result: instead of the swap being out of the money by £1mm and collaterased by that amount, the restruck swap has a MTM of 0 and neither party holds any collateral.

Cash Settlement mechanics generally

Section 8.6, Cash Settlement of Equity Swap Transactions, provides, more or less, that where “Cash Settlement” applies, a payment is made on each Cash Settlement Payment Date depending on the Type of Return specified.

• Price Return is simply a function of the price at the beginning and end, and takes no account of declared dividends or other income or distributions received off the underlier in the mean time. It is simply the the Equity Notional Amount * Rate of Return (where Rate of Return is ((Final Price - Initial Price)/Initial Price) * Multiplier (if any)); the Equity Amount, paid one way or the other depending on whether it is positive or negative)
• Total Return is the Price Return, but adjusted for income:
  • if Re-investment of Dividends does not apply, applicable Dividend Amounts will also be paid by the Equity Amount Payer (along with the Equity Amount, whichever way it might be paid, as per Price Return);
  • if Re-investment of Dividends does apply, then Equity Amounts will be adjusted as per the “Re-investment of Dividends” provision.
• Slight return takes you to a whole different world altogether. The next one, in fact. Don’t be late!

Bullet swaps

Remembering, of course that the “calculation period” for an Equity Amount Payer is a function of the specified Valuation Dates — there is no specific concept of a “calculation period” in the 2002 ISDA Equity Derivatives Definitions — If the only specified Valuation Date is the Termination Date, then the whole Equity Notional Reset is moot, since no Equity Notional Reset will occur during the life the Transaction in any case.

User Guide

Adapted from the User Guide:

Equity Notional Reset has been amended from the 1996 Definitions by Section 5.10 of the 2002 Definitions to reflect the change in terminology from "Equity Payment Date” to "Cash Settlement Payment Date".

If "Equity Notional Reset” is specified then for the first Cash Settlement Payment Date, the Equity Notional Amount is the amount specified in the Confirmation and, for subsequent Cash Settlement Payment Dates, it is the sum of the Equity Notional Amount in respect of the prior Cash Settlement Payment Date and the Equity Amount in respect of the prior Cash Settlement Payment Date.

Lastly, if a "Notional Amount” has been specified in the Confirmation, such amount will be adjusted as set forth in Sections 5.10(a) and (b) as though it were an Equity Notional Amount.

If parties wish to extend the Floating Amount Payer Calculation Period in the situation where a Payment Date does not correspond with a Cash Settlement Payment Date, they should consider including the following additional language to the end of the definition of Payment Date:

"provided that, if on such date the corresponding Cash Settlement Payment Date has not yet occurred, such Payment Date shall be postponed to the date on which the Cash Settlement Payment Date occurs and the Floating Amount Payer shall pay the Floating Amount due in relation to the relevant Calculation Period on that postponed Payment Date."

As an alternative to extending the Floating Amount Payer Calculation Period in this situation, the parties may wish to defer payment of the Floating Amount to the Cash Settlement Payment Date, and accrue interest during that period. lf the parties wish to take that approach, they may wish to consider adding the following language:

", provided that, if on such date (the "Original Payment Date") the corresponding Cash Settlement Payment Date has not yet occurred, (i) the Calculation Period will be deemed to end on (but exclude) the Original Payment Date, (ii) interest will accrue on the Floating Amount from (and including) the Original Payment Date to (but exch1ding) the Cash Settlement Payment Date at [ ] calculated on the basis of daily compounding and the actual number of days elapsed and (iii) the Floating Amount Payer shall pay the relevant Floating Amount, together with any accrued interest, on the Cash Settlement Payment Date".