2002 ISDA Equity Derivatives Definitions
A Jolly Contrarian owner’s manual™
Triple Cocktail in a Nutshell™
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Triple Cocktail in all its glory
The famous Triple Cocktail™
— a trilogy in five parts:
- 12.9(a)(ii) “Change in Law” means that, on or after the Trade Date of any Transaction:
- (A) due to the adoption of or any change in any applicable law or regulation (including, without limitation, any tax law), or
- (B) due to the promulgation of or any change in the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law or regulation (including any action taken by a taxing authority),
- a party to such Transaction determines in good faith that:
- (X) it has become illegal to hold, acquire or dispose of Shares relating to such Transaction, or
- (Y) it will incur a materially increased cost in performing its obligations under such Transaction (including, without limitation, due to any increase in tax liability, decrease in tax benefit or other adverse effect on its tax position);
- 12.9(a)(v) “Hedging Disruption” means that the Hedging Party is unable, after using commercially reasonable efforts, to (A) acquire, establish, re-establish, substitute, maintain, unwind or dispose of any transaction(s) or asset(s) it deems necessary to hedge the equity price risk of entering into and performing its obligations with respect to the relevant Transaction, or (B) realize, recover or remit the proceeds of any such transaction(s) or asset(s);
- 12.9(a)(vi) “Increased Cost of Hedging” means that the Hedging Party would incur a materially increased (as compared with circumstances existing on the Trade Date) amount of tax, duty, expense or fee (other than brokerage commissions) to (A) acquire, establish, re-establish, substitute, maintain, unwind or dispose of any transaction(s) or asset(s) it deems necessary to hedge the equity price risk of entering into and performing its obligations with respect to the relevant Transaction, or (B) realize, recover or remit the proceeds of any such transaction(s) or asset(s), provided that any such materially increased amount that is incurred solely due to the deterioration of the creditworthiness of the Hedging Party shall not be deemed an Increased Cost of Hedging;
- 12.9(a)(vii) “Loss of Stock Borrow” means that the Hedging Party is unable, after using commercially reasonable efforts, to borrow (or maintain a borrowing of) Shares with respect to such Transaction in an amount equal to the Hedging Shares (not to exceed the number of Shares underlying the Transaction) at a rate equal to or less than the Maximum Stock Loan Rate;
- 12.9(a)(viii) “Increased Cost of Stock Borrow” means that the Hedging Party would incur a rate to borrow Shares in respect of such Transaction that is greater than the Initial Stock Loan Rate;
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These provisions are often carried over to an equivalent triple cocktail in the 2005 ISDA Commodity Definitions — but hte 2002 ISDA Equity Derivatives Definitions got there first. A few years later they were rewritten in enormous, painstaking, pain-inflicting, detail by a Linklaters combat squadron, for the machine age 2011 Equity Derivatives Definitions, but tragically the squadron disappeared without trace over the Bermuda Triangle in hurricane season that year. Since all copies of the new definitions were on board, no-one knows what became of them, we can only now wonder what they might have said.
The “triple cocktail” is the JC’s shorthand for the collection of Additional Disruption Events that can justify a broker terminating, or repricing, an equity derivatives Transaction. There is a fundamental asymmetry at play in a delta-one equity swap: the customer can get in or out at any time at will and without excuse as long as it has the resources to meet any margin calls that might come along. It is a synthetic version of buying a share on margin: the customer, and not the broker decides when and if to buy or sell, and accordingly can stay in as song as it pleases.
The broker is therefore, effectively, committed: as long as it is adequately collateralised — which is what its margin and hedge arrangements do — it should not have any reason to terminate the trade. Of course, the development over time of capital regulations, which take a dim view of indefinite commitments, put something of a gloss on that, and brokers will usually insist on some kind of 90-day break right, but this is to cheer the crowd in their treasury department, not because they would ever insist on using it.
But there are some cases in which they might need to get out, and quicker than on 90 days’ notice. These are the Additional Disruption Events of the triple cocktail. These are events that materially impact on the broker’s ability to manage its market risk and funding requirements. Okay, there are five, but the main ones are the first three:
Change in Law
Increased Cost of Hedging
Loss of Stock Borrow
Increased Cost of Stock Borrow.
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