Template:M gen GMRA 10

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Should failure to deliver be an Event of Default under a repo?

The 2000 Global Master Repurchase Agreement provides that the parties may agree that any failure to deliver securities can be declared an Event of Default. If a one occurs, the day after the delivery was expected the intended recipient can terminate and cover all open positions, meaning that the party expected to deliver the securities must pay the bid-offer spread on all open positions.

This is a significant difference from its predecessor, the 1995 Global Master Repurchase Agreement, in which a failure to deliver securities to initiate a repo was not an Event of Default or a breach of agreement, and a failure to redeliver securities at the end of a repo allows the lender to buy in securities to cover the fail.

Note under both versions, a failure to deliver collateral is an Event of Default.

Delivery failures are a feature of the market

Delivery failures are frequent in the repo market and may occur for a number of reasons:

  • Operational failure, such as a mismatch of instructions or a late booking
  • A third party may fail to deliver to the party expecting to deliver under the repo
  • Lack of availability of the securities to deliver, say, due to the bonds going “special”
  • A lender may lose the expected supply – for example a custodian may expect to lend but the owner of the securities sells before the repo settles
  • Exceptionally, due to lack of funds at the deliverer

Making them Events of Default would put participants in a perpetual state of default.

The purpose of Events of Default

The Events of Default are protections are there for the end-of-days scenario: one side is in Iron Mountain boxville; the other wants out immediately. They are not meant for non-insolvency situations where one party may have technically breached agreement, but without material credit deterioration. In those circumstances, the parties can rely on the normal contractual remedies for breach of contract.

Compare delivery failures of the underlying security and delivery failures concerning the delivery of collateral: A party has a choice with collateral: whether to use collateral or cash, what collateral to deliver and so on. There is less excuse for screwing this up. If a party takes that choice and fails to deliver, the expected recipient is entitled to consider that the failure may represent a credit concern. Many participants use cash collateral to avoid the settlement risks of securities.

Why does the 2000 GMRA take a different approach to the 1995?

Americans, in a word. During the drafting process the ISMA’s crack drafting squad™ US banks came in mob-handed wanting delivery failure be an event of default, due to their experience of US Treasuries repo, where delivery failures are rare.

Many European banks were opposed. ISMA’s crack drafting squad™ provided in the GMRA 2000 for a choice for the parties to make a delivery failure an Event of Default.

What is the protection for an expected recipient if a delivery failure occurs?

Deliveries in repo typically occur delivery versus payment, with the cash only moving if the security settlement details match and settle. This means that if a delivery of securities fails, the expected recipient of the securities will not deliver the cash and: (i) If the failure was by the lender at the start of the repo, no repo would be entered into, and neither party has any exposure on the failed repo. Only if the deliverer has agreed “guaranteed delivery” would a borrower consider that there was a breach of contract for a failure to deliver. The parties may seek to start the repo by attempting delivery over the next few days, or if this proves impractical the repo is never entered into. (ii) If the failure was by the borrower at the end of the repo, the lender would not return the cash, and each party has the same exposure that it did the previous day (other than market movements on the securities).

A sensible approach?

Some scholars—okay: one, and no it isn’t the Jolly Contrarian although he does get the point—have intimated that the 1995 Global Master Repurchase Agreement got this right and the 2000 Global Master Repurchase Agreement got it wrong. For the following reasons:

  • Initiation: A delivery failure by a Lender when initiating a repo has no consequence – it is neither an Event of Default, nor a breach of contract. Section 10(g) allows the Buyer to terminate the repo at any time while the delivery failure is continuing or to work with the Seller to initiate the repo on a later date.
  • Scheduled maturity: A redelivery failure by a Borrower at term is not an Event of Default. Rather, the Lender may buy in the securities using section 10(h).
  • Collateral delivery failure: A failure by either party to deliver collateral when required is an Event of Default.

This correctly addresses the credit concerns that a party may justifiably have under a repo relationship, while also reflecting the intentions of the transacting parties when entering into repos.

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