Triple Cocktail - Equity Derivatives Provision

2002 ISDA Equity Derivatives Definitions
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Section Triple Cocktail in a Nutshell™

Use at your own risk, campers!

The famous Triple Cocktail™ — a trilogy in five parts: 12.9(a)(ii) “Change in Law” means either party determines that, due to a change in law or regulation: (X) it becomes illegal to buy, sell or hold underlying Shares or; (Y) it becomes materially more expensive to perform the Transaction. 12.9(a)(v) “Hedging Disruption” means that the Hedging Party cannot reasonably acquire, hold, replace or unwind any transactions hedging its equity price risk, or realise, recover or pay the proceeds of any hedging transactions. 12.9(a)(vi) “Increased Cost of Hedging” means that the Hedging Party would incur a materially increased cost under the Transaction to: (A) hedge its equity price risk; or (B) realise the proceeds of its hedge. This excludes costs arising solely from the deterioration of its own creditworthiness. 12.9(a)(vii) “Loss of Stock Borrow” means that, having used commercially reasonable efforts, the Hedging Party cannot borrow the Shares it needs to hedge the Transaction at a rate equal to or lower than the Maximum Stock Loan Rate; 12.9(a)(viii) “Increased Cost of Stock Borrow”: the rate the Hedging Party incurs to borrow Shares for the Transaction exceeds the Initial Stock Loan Rate; view template

Full text of Section Triple Cocktail

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; view template

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Content and comparisons

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.

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Summary

Triple Cocktail — a trilogy in five parts

Should a Hedging Party have trouble hedging an equity derivative the 2002 ISDA Equity Derivatives Definitions contain a “triple cocktail” of protections:

Change in Law: due to a change in law after Trade Date it becomes (a) flat-out illegal [or (b) materially more expensive]^[1] for the Hedging Party to “deal with its hedge”^[2].
Hedging Disruption: The Hedging Party can’t deal with, or recover the proceeds of a hedge.
Increased Cost of Hedging: the Hedging Party would incur material additional costs in (a) dealing with its hedge or (b) realising its proceeds^[3], excluding costs due to the deterioration of its own credit;
Loss of Stock Borrow: The Hedging Party cannot maintain the stock borrow it needs to put on a short position on swap;
Increased Cost of Stock Borrow: The cost to the Hedging Party of maintaining the stock borrow it needs to hedge a short position on swap exceeds the Initial Stock Loan Rate, being a kind of “at this point the pips squeak” kind of threshold for the dealer.

Consequences

The parties’ rights as a result of each differ, and are set out in Section 12.9(b). Plenty more chat there.

Termination

However a Transaction is terminated the Determining Party (i.e., and not the Calculation Agent^[4] determines the Cancellation Amount, depending on whether Cancellation and Payment or Partial Cancellation and Payment applies.

Interaction

The three elements cover different bases (hence why the “material costs” in Change in Law is often omitted: it is really just a specific case of “Increased Cost of Hedging”).

Change in Law is about the regulations governing the Hedging Party. There may be plenty of liquidity in hedge-appropriate investments, they may be inexpensive, but Hedging Party isn’t allowed to buy any of them.
Hedging Disruption is about liquidity and the outright absence of assets to buy as a hedge. It’s perfectly legal to hedge, the financing costs of cracking out a hedge are tolerable, but no-one is selling a hedge.
Increased Cost of Hedging: is about the cost to the Hedging Party of acquiring a hedge — not the asset price itself — your counterparty wears that, so what do you care? — but the costs to the Hedging Party of acquiring it: financing costs, capital costs, stamp duties, transaction costs and so on. Largely, it will be financing costs. If the market has gone all September 2018, suddenly credit spreads on on the Hedging Party’s financing operation are have gone through the roof, and when it lends out its hedges as collateral for upgrade trades Agent Lenders are haircutting them by how much did you say??

Loss of Stock Borrow

A Loss of Stock Borrow which would also be a Hedging Disruption will be treated as a Loss of Stock Borrow and not a Hedging Disruption.^[5]