Termination Event - ISDA Provision
Content and comparisons
A comparison between the 1992 ISDA and the 2002 ISDA can be found on the ISDA Comparison page.
A Termination Event is an event justifying one party unilaterally terminating a Transaction — or sometimes all Transactions — but that is generally of a nature that does not cast aspersions of impropriety on the other, or “Affected”, party. This makes a difference when it comes to how one calculates the Close-out Amount for the Transaction in question.
Summary
Adding any new Termination Event must ALWAYS be achieved by labelling it a new “Additional Termination Event” under Section 5(b)(vi), and not a separate event under a new Section 5(b)(vii) etc.
If, instead of being expressed as an “Additional Termination Event”, which is how the ISDA Mechanism is intended to operate, it is set out as a new “5(b)(vii)” it is not designated therefore as any of an “Illegality”, “Tax Event”, “Tax Event Upon Merger”, “Credit Event Upon Merger” or “Additional Termination Event”, so therefore, read literally, is not caught by the definition of “Termination Event” and none of the Termination provisions bite on it.
I mention this because we have seen it happen. You can take a “fair, large and liberal view" that what the parties intended was to create an ATE, but why suffer that anxiety?
General discussion
The financial difference between an Affected Party and a Defaulting Party
What is the practical, economic difference between being closed out on the same Transaction for an Event of Default and a Termination Event? This is something that all ISDA ninjas know, or sort of intuit, in a sort of semi-conscious, buried-somewhere-deep-in-the-brain-stem kind of way, but they may mutter darkly and try to change the subject if you ask them to articulate it in simple English.
The topic might be chiefly of academic interest were it not for the unfortunate habit of the same “real world” event potentially comprising more than one variety of termination right. This leads to some laboured prioritisation in the ISDA, and sometimes some in the Schedule too. What if my Tax Event upon Merger is also a Credit Event Upon Merger, and also a Force Majeure? that kind of question.
So, with feeling, here it is:
The Definition of Close-out Amount
Remember the way a Determining Party values a Terminated Transaction is calculates its own close-out value — in our nutshell terms, “the losses the Determining Party would incur (positive) or gains it would realise (negative) in replacing the material terms and the option rights of the parties under a Terminated Transaction”. One assesses “the costs one would incur” from ones’ own side of the market. A large party of the question comes down to who the Determining Party is for a given termination event.
Defaulting Party
Under an Event of Default, it is the Non-Defaulting Party at all times (since on the theory of the game, the Defaulting Party is either a miscreant or a smoking hulk of twisted metal, there is no one else around to do this. Therefore, it being an Event of Default is always optimal for the Innocent Party, since it will always be the Determining Party.
One Affected Party
Where the terminating impetus is not so outrageous as to qualify as an Event of Default — i.e., it is only a Termination Event — but it only impacts one party, in most cases it is the same as for an Event of Default. There is one Affected Party, the Non-Affected Party is the sole Determining Party, so it closes out on its own side of the market ... unless the event in question is an Illegality or a Force Majeure Event, in which case there is a rider in Section 6(e)(ii)(3) applies and the Determining Party has to get mid market quotations that don’t take its own creditworthiness into account. But note that the most commonly triggered type of Termination Event is an Additional Termination Event, these tend to have a defaulty, turpidudinous character about them, almost never happen to two people at once, and therefore behave exactly like Events of Default.
Two Affected Parties
When both parties are affected — a scenario the ISDA only contemplates for Termination Events; Events of Default being more of a “she who draws first wins” sort of affair, where the first in time prevails — then each party is a “Determining Party” calculates its own close-out value — in our nutshell terms, “the losses the Determining Party would incur (positive) or gains it would realise (negative) in replacing the material terms and the option rights of the parties under a Terminated Transaction” — throws it into the ring and the Calculation Agent splits the difference. Assuming both parties calculate so the end result is necessarily a mid-market number.
All so confusing. If only there were someone to set it all out in a table for you.
Awwwwww.
| Event | How many affected | What happens |
|---|---|---|
Events of DefaultQ.E.D. there is only one Defaulting Party: |
Defaulting Party only | Non-defaulting Party calculates on its own side of market. |
Termination Events where there is only one Affected PartyAnd this odd rider in Section 6(e)(ii)(3) requiring a midmarket price does not apply: |
One Affected Party only | Non-Affected Party calculates on its own side of market. |
Termination Events where there is only one Affected Party but ...This odd rider in Section 6(e)(ii)(3) requiring a midmarket price does apply: |
One Affected Party only | Non-Affected Party seeks prices by reference to mid-market values and which do not reflect its own credit. |
Termination Events where there are two Affected Parties5(b)(i) Illegality |
Each party is an Affected Party | Both parties are Determining Parties, and Calculation Agent splits the difference ergo it is a midmarket rate. |