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PART I: PRELIMINARY

MI by 2002
MI by 2002

Comparisons

The 1987 ISDA, being concerned only with interest rates and currency exchange, does not contemplate delivery, as such. Delivery implies non-cash assets. Therefore portions of 2(a)(i) and 2(a)(ii) were augmented in the 1992 ISDA to cater for this contingency. The 1992 ISDA also added a condition precedent to the flawed asset clause (Section 2(a)(iii)) that no Early Termination Date had been designated.

Thereafter Section 2(a) is identical in the 1992 ISDA and the 2002 ISDA. However the subsidiary definition of Scheduled Settlement Date — a date in which any Section 2(a)(i) obligations fall due — is a new and frankly uncalled-for innovation in the 2002 ISDA.

We have a special page dedicated to Section 2(a)(iii), by the way. That is a brute, and one of the most litigationey parts of the Agreement.

Summary

Section 2 contains the basic nuts and bolts of your obligations under the Transactions you execute. Pay or deliver what you’ve promised to pay or deliver, when you’ve promised to pay it or deliver it, and all will be well.

“Scheduled Settlement Date”

Though it doesn’t say so, at least in the 2002 ISDA the date on which you are obliged to pay or deliver an amount is the “Scheduled Settlement Date”. The ’02 definition only shows up only in Section 2(b) (relating to the time by which you must have notified any change of account details) and then, later, in the tax-related Termination Events (Tax Event and Tax Event Upon Merger). That said, “Scheduled Settlement Date” isn’t defined at all in the 1992 ISDA.

Section 2(a)(iii): the flawed asset provision

And then there’s the mighty flawed asset provision of Section 2(a)(iii). This won’t trouble ISDA negotiators on the way into a swap trading relationship — few enough people understand it sufficiently well to argue about it — but if, as it surely will, the great day of judgment should visit upon the financial markets again some time in the future, expect plenty of tasty argument, between highly-paid King’s Counsel who have spent exactly none of their careers considering derivative contracts, about what it means.

We have some thoughts on that topic, should you be interested, at Section 2(a)(iii).

Flawed assets

Section 2(a)(iii): Of these provisions, the one that generates the most controversy (chiefly among academics and scholars, it must be said) is Section 2(a)(iii). It generates a lot less debate between negotiators, precisely because its legal effect is nuanced, so its terms are more or less inviolate. Thus, should your counterparty take a pen to Section 2(a)(iii), a clinching argument against that inclination is “just don’t go there, girlfriend”.

Payments and deliveries

In a rare case of leaving things to practitioners’ common sense, ISDA’s crack drafting squad™ deigned not to say what it meant by “payment” or “delivery”.

Payments

Payments are straightforward enough, we suppose — especially since they are stipulated to be made in “freely transferable funds and in the manner customary for payments in the required currency”: beyond that, money being money, you either pay or you don’t: there are not too many shades of meaning left for legal eagles to snuggle into.

Deliveries

Deliveries, though, open up more scope for confecting doubts one can then set about avoiding. what does it mean to deliver? What of assets in which another actor might have some claim, title or colour of interest? In financing documents you might expect at least a representation that “the delivering party beneficially owns and has absolute rights to deliver any required assets free from any competing interests other than customary liens and those arising under security documents”.

What better cue could there be for opposing combatants leap into their trenches, and thrash out this kind of language?

Less patient types — like yours truly — might wish to read all of that into the still, small voice of calm of the word “deliver” in the first place.

What else could it realistically mean, but to deliver outright, and free of competing claims? It is bound up with implications about what you are delivering, and whose the thing is that you are delivering. It would be absurd to suppose one could discharge a physical delivery obligation under a swap by “delivering” an item to which one had no title at all: it is surely implicit in the commercial rationale that one is transferring, outright, the value implicit in an asset and not just the formal husk of the asset itself, on terms that it may be whisked away at any moment at the whim of a bystander.

Swaps are exchanges in value, not pantomimes: one surrenders the value of the asset for whatever value one’s counterparty has agreed to provide in return. Delivery is not just some kind of performative exercise in virtue signalling. You have to give up what you got. As the bailiffs take leave of your counterparty with the asset you gave it strapped to their wagon, it would hardly do to say, “oh, well, I did deliver you that asset: it never said anywhere it had to be my asset, or that I was meant to be transferring any legal interest in it to you. It is all about my act of delivery, I handed something to you, and that is that.”

We think one could read that into the question of whether a delivery has been made at all. Should a third party assert title to or some claim over an asset delivered to you, your best tactic is not a vain appeal to representations your counterparty as to the terms of delivery, but to deny that it has “delivered” anything at all. “I was meant to have the asset. This chap has repossessed it; therefore I do not have it. If I don’t have it, it follows that you have failed to deliver it.”

Modern security as practical control

In any weather, nowadays much of this is made moot by the realities of how financial assets are transferred: that is, electronically, fungibly, in book-entry systems, and therefore, by definition, freely: a creditor takes security over accounts to which assets for the time being are credited, or by way of physical pledge where the surety resides in the pledgee holding and therefore controlling the securities for itself. It is presumed that, to come about, any transfer of assets naturally comes electronically and without strings attached. It would be difficult for such a security holder to mount a claim for an asset transferred electronically to a bona fide third party recipient for value and without notice: the practicalities of its security interest lie in its control over the asset in the first place: holding it, or at the least being entitled to stop a third party security trustee or escrow custodian delivering away the asset without the security holder’s prior consent.

Comparisons

But for the new definition of Scheduled Settlement Date in the 2002 ISDA, the 1992 ISDA text is formally the same.

Summary

ISDA’s crack drafting squad™ phoning it in, we are obliged to say, and not minded to make any better a job of it when given the opportunity to in 2002. On the other hand, in this time of constant change, it is reassuring to know some things just stay the same.

General discussion

Template:M gen 2002 ISDA 2(b)

Comparisons

The 2002 ISDA introduces the concept of Multiple Transaction Payment Netting, thereby correcting a curiously backward way of applying settlement netting.

Summary

Section 2(c) is about “settlement” or “payment” netting — that is, the operational settlement of offsetting payments due on any day under the normal operation of the Agreement — and not the more drastic close-out netting, which is the Early Termination of all Transactions under Section 6.

If you want to know more about close-out netting, see Single Agreement and Early Termination Amount.

We wonder what the point of this section is, since settlement netting is a factual operational process for performing existing legal obligations, rather than any kind of variation of the parties’ rights and obligations. If you owe me ten pounds and I owe you ten pounds, and we agree to both keep our tenners, what cause of action arises? What loss is there? We have settled our existing obligations differently.

To be sure, if I pay you your tenner and you don’t pay me mine, that’s a different story — but then there is no settlement netting at all. The only time one would wish to enforce settlement netting it must, ipso facto, have happened, so what do you think you’re going to court to enforce?

Transaction flows and collateral flows

In a fully margined ISDA Master Agreement, all other things being equal, the termination of a Transaction will lead to two equal and opposite effects:

• A final payment or exchange under the Transaction having a value more or less equal to the present value of that Transaction;
• A offsetting change in the Exposure under the CSA in exactly the same value.

The strict sequence of these payments ought to be that the Transaction termination payment goes first, and the collateral return follows, since it can only really be calculated and called once the termination payment has been made.

I know what you’re thinking. Hang on! that means the termination payer pays knowing this will increase its Exposure for the couple of days it will take for that collateral return to find its way back. That’s stupid!

What with the regulators’ obsession minimise systemic counterparty credit risk, wouldn’t it be better to apply some kind of settlement netting in anticipation, to keep the credit exposure down?

Now, dear reader, have you learned nothing? It might be better, but “better” is not how ISDA documentation rolls. The theory of the ISDA and CSA settlement flows puts the Transaction payment egg before the variation margin chicken so, at the moment, Transaction flows and collateral flows tend to be handled by different operations teams, and their systems don’t talk. Currently, the payer of a terminating transaction has its heart in its mouth for a day or so.

Industry efforts to date have been targeting at shortening the period between the Exposure calculation and the final payment of the collateral transfer.

Comparisons

Other than an “on or after the date on which” embellishment towards the end of the clause, exactly the same text in the 1992 ISDA and the 2002 ISDA.

Summary

Section 2(d) does the following:

• Net obligation: if a counterparty suffers withholding it generally doesn’t have to gross up – it just remits tax to the revenue and pays net.
• Refund obligation where tax subsequently levied: if a counterparty pays gross and subsequently is levied the tax, the recipient must refund an equivalent amount to the tax.
• Indemnifiable Tax: the one exception is “Indemnifiable Tax” - this is tax arises as a result of the payer’s own status vis-à-vis the withholding jurisdiction. In that case the payer has to gross up, courtesy of a magnificent quintuple negative.

Stamp Tax reimbursement obligations are covered at 4(e), not here.

News from the pedantry front

Happy news, readers: we have a report from the front lines in the battle between substance and form. The JC asked no lesser a tax ninja than Dan Neidle — quietly, the JC is a bit of a fan — the following question:

In the statement, “X may make a deduction or withholding from any payment for or on account of any tax” is there any difference between “deducting” and “withholding”?

They seem to be exact synonyms.

Likewise, “for” vs. “on account of”?

We are pleased to report Mr N opined replied:

I don’t think there’s a difference. Arguably it’s done for clarity, because people normally say “withholding tax” but technically there’s no such thing — it’s a deduction of income tax.

Which is good enough for me. So all of that “shall be entitled to make a deduction or withholding from any payment which it makes pursuant to this agreement for or on account of any Tax” can be scattered to the four winds. Henceforth the JC is going with:

X may deduct Tax from any payment it makes under this Agreement.

General discussion

Template:M gen 2002 ISDA 2(d)

Details

MI by 2002

Comparisons

The Section 3(a) Basic Representations survived intact, to the last punctuation mark, between the 1992 ISDA and the 2002 ISDA. They were that excellent.

Summary

An observant negotiator (is there any other kind?) handling a 1992 ISDA might wish to add a new agency rep as Section 3(a)(vi). In 2002, ISDA’s crack drafting squad™ obviously thought this was such a good idea that they added a brand-new “no-agency” rep to the 2002 ISDA, only they can’t have felt it was basic enough to go in the Basic Representations, so they put it in a new clause all by itself at Section 3(g).

But you don’t need a bespoke “no-agency” rep if you’re on a 2002 ISDA, if that’s what you’re wondering.

3(a)(v) Obligations Binding

“any Credit Support Document to which it is a party”: Business at the front; party at the back.

Now given that a Credit Support Document will generally be a deed of guarantee, letter of credit or some other third party form of credit assurance from a, you know, third party to which a Party in whose favour it is provided will not be a “party” — and no, an 1995 CSA is not a Credit Support Document, however much it might sound like one, one might wonder what the point would be of mentioning, in this sub-section, Credit Support Documents to which a Party is party.

Well — and this might come as a surprise if you’re an ISDA ingénue; old lags won’t bat an eyelid — there isn’t much point.

But does anyone, other than the most insufferable pedant, really care? I mean why would you write a snippy wiki article about some fluffy but fundamentally harmless language unless you were a stone-cold bore?

Hang on: Why are you looking at me like that?

Comparisons

No change from 1992 ISDA to 2002 ISDA.

Summary

Can you understand the rationale for this representation? Sure.

Does it do any practical good? No.

It is a warranty, not a representation

A standard, but useless, contractual warranty. It can’t be a pre-contractual representation, of course, because the very idea of an “event of default” depends for its intellectual existence on the conclusion of the contract in which it is embedded. So, it won’t really do to argue there should be no contract, on grounds of the false representation that a contract that does not exist has not been breached.

It is paradoxes all the way down

A No EOD rep is a classic loo paper rep: soft, durable, comfy, absorbent — super cute when a wee Labrador pub grabs one end of the streamer and charges round your Italian sunken garden with it — but as a credit mitigant or a genuine contractual protection, only good for wiping your behind on.

Bear in mind you are asking someone — on pain of them being found in fundamental breach of contract — to swear to you they are not already in fundamental breach of contract. Now, how much comfort can you genuinely draw from such promise? Wouldn’t it be better if your credit team did some cursory due diligence to establish, independently of the say-so of the prisoner in question, whether there are grounds to suppose it might be in fundamental breach of contract?

Presuming there are not — folks tend not to publicise their own defaults on private contracts, after all — the real question here is, “do I trust my counterparty?” And to that question, any answer provided by the person whose trustworthiness is in question, carries exactly no informational value. All cretins are liars.

So, let’s say it turns out your counterparty is lying; there is a pending private event of default it knew about and you didn’t. Now what are you going to do? Righteously detonate your contract on account of something of which by definition you are ignorant?

Have fun, counsellor.

“...or potential event of default”

Adding potential events of default is onerous, especially if it is a continuous representation, as it deprives the representor of grace periods it has carefully negotiated into its other payment obligations. Yes, it is in the ISDA Master Agreement.

“... or would occur as a result of entering into this agreement”

A curious confection, you might think: what sort of event of default could a fellow trigger merely by entering into an ISDA Master Agreement with me? Well, remember the ISDA’s lineage. It was crafted, before the alliance of men and elves, by the Children of the Woods. They were a species of pre-derivative, banking people. It is possible they had in mind the sort of restrictive covenants a banker might demand of a borrower with a look of softness about its credit standing: perhaps a promise not to create material indebtedness to another lender, though in these enlightened times that would be a great constriction indeed on a fledgling enterprise chasing the world of opportunity that lies beyond its door.

So, does a swap mark-to-market exposure count as indebtedness? Many will recognise this tedious question as one addressed at great length when contemplating a Cross Default: Suffice, here, to say that an ISDA isn’t “borrowed money” as such, but a material swap exposure would have the same credit characteristics as indebtedness. But in these days of compulsory variation margin you wouldn’t expect one’s mark-to-market exposure to be material, unless something truly cataclysmic was going on intra-day in the markets.

Much more likely is a negative pledge, and while an unsecured, title-transfer, close-out netted ISDA might not offend one of those, a Pledge GMSLA might, and a prime brokerage agreement may well do.

But still, nonetheless, see above: if it does, and your counterparty has fibbed about it, all you can do is get out your tiny violin.

Comparisons

Section 3(c) was one of the bits of the 1992 ISDA that ISDA’s crack drafting squad™ “got mostly right” at the first time of asking. But still, some bright sparks on the ’Squad took it upon themselves, in the 2002 ISDA, to switch out reference to “Affiliates” which — I don’t know, might take in some distant half-bred cousin you don’t enormously care about and who doesn’t cast any real shadow on your creditworthiness — with “Credit Support Providers” and “Specified Entities” who no doubt more keenly do, but this leads to just more fiddliness in the Schedule over-stuffed with fiddliness, since one must then go to the trouble of specifying, and then arguing with your counterparties about, who should count as a Specified Entity for this remote and rather vacuous purpose.

Keeps the home fires burning in the hobbity shires where ISDA negotiators make their homes, we suppose.

Summary

Reference to Affiliates can be controversial, particularly for hedge fund managers.

More generally, absence of litigation is a roundly pointless representation, but seeing as (other than unaffiliated hedge fund managers) no-one complains about it, it is best to just leave well alone.

Absence of litigation generally

An absence of litigation representation seeks to address litigation carrying two particular risks:

• Enforceability: Litigation that could somehow undermine or prejudice the very enforceability of life was we know it (a.k.a the agreement you are presently negotiating);
• Credit deterioration: Litigation that is so monstrous in scope that it threatens to wipe your counterparty from the face of the earth altogether, while it still owes you under the agreement you’re negotiating.

Enforceability-threatening litigation

Firstly, Earth to Planet ISDA: what kind of litigation or regulatory action — we presume about something unrelated to this agreement since, by your theory, it doesn’t damn well exist yet — could adversely impact in the enforceability of this future private legal contract between one of the litigants and an unrelated, and ignorant, third party?

Search me. But still, I rest assured there will an ISDA boxwallah out there somewhere who could think of something.

Existentially apocalyptic litigation

Look, if your counterparty is banged up in court proceedings so awful to behold that an adverse finding might bankrupt it altogether, and your credit sanctioning team hasn’t got wind of it independently then, friend, you have way, way bigger problems than whether you have this feeble covenant in your docs. And, if you are only catching it at all thanks to a carelessly given absence of litigation rep, by the time said litigation makes itself known to you. won’t it be a bit late?

Deemed repetition

Ah, you might say, but what about the deemed repetition of this representation? Doesn’t that change everything?

Deemed repetition

What of this idea that one not only represents and warrants as of the moment one inks the paper, but also is deemed to repeat itself an the execution of each trade, on any day, or whenever a butterfly flaps its wings on Fitzcarraldo’s steamer? Do we think it works? Do we? Given how practically useless even explicit representations are, does it really matter?

And, having given it, how are you supposed to stop a continuing representation once it has marched off into the unknowable future, like one of those conjured brooms from the Sorcerer’s Apprentice? If you don’t stop it, what then? This may seem fanciful to you, but what are buyside lawyers if not creatures of unlimited, gruesome imagination? Are their dreams not full with flights of just this sort of fancy? Rest assured that, as you do, they will be chewing their nails to the quick in insomniac fever about this precise contingency.

For which reason — it being a faintly pointless representation in the first place and everything — it might be best just to concede this point when it arises, as inevitably it will.

Pick your battles

All that said, and probably for all of the above reasons, parties tend not to care less about this representation, so your practical course is most likely to leave it where you find it.

Comparisons

ISDA’s crack drafting squad™ must have got this spot-on in their first attempt in 1992, because their successors in 2002 could not find so much as an inverted comma to change.

Summary

The fabulous Section 3(d) representation, giving one’s counterparty the right to close out should any so-designated representations turn out not to be true. This is sure to occupy an inordinate amount of your negotiation time — in that it occupies any time at all — because you are as likely to be hit in the face by a live starfish in the Gobi Desert as you are to close out an ISDA Master Agreement because your counterparty is late in preparing its annual accounts. But that’s a personal view and you may not rely on it.

The 3(d) representation, in the documents for delivery table in the Schedule, therefore covers only the accuracy and completeness of Specified Information and not (for example) whether Specified Information is delivered at all. For that, see Section 4(a) - Furnish Specified Information.

“Covered by the Section 3(d) Representation”

If one is required to “furnish” Specified Information under Section 4, two things can go wrong:

No show: One can fail to provide it, at all, in which case there is a Breach of Agreement, but be warned: the period before one can enforce such a failure, judged by the yardstick of modern financial contracts, is long enough for a whole kingdom of dinosaurs to evolve and be wiped out; or

It’s cobblers: One can provide the Specified Information, on time, but it can be a total pile of horse ordure. Now, here is a trick for young players: if your Specified Information is, or turns out to be, false, you have no remedy unless you have designated that it is “subject to the Section 3(d) representation”. That is the one that promises it is accurate and not misleading.

Might Section 3(d) not cover a representation?

Now you might ask what good an item of Specified Information can possibly be, if Section 3(d) didn’t apply and it could be just made up on the spot without fear of retribution — as a youngster, the JC certainly asked that question, and has repeated it over many years, and is yet to hear a good answer — but all we can presume is that in its tireless quest to cater for the unguessable predilections of the negotiating community, ISDA’s crack drafting squad™ left this preposterous option open just in case. It wouldn’t be the first time.

Legal opinions, and Credit Support Documents

A trawl through the SEC’s “Edgar” archive reveals that the sorts of things to which “Covered by Section 3(d) Representation” results in a “No” outcome are rare — but not non-existent. It is things like “Legal opinion from counsel concerning due authorization, enforceability and related matters, addressed to the other party and reasonably acceptable to such other party”, or “Credit Support Documents”.
See further discussion in the sections below.

Annual reports

The other little fiddle — and it is a little fidgety fiddle — is to remark of annual reports that, yes, they are covered by that Section 3(d) representation, but with a proviso:

“Yes; provided that the phrase “is, as of the date of the information, true, accurate and complete in every material respect” in Section 3(d) shall be deleted and the phrase “fairly presents, in all material respects, the financial condition and results of operations as of their respective dates and for the respective periods covered thereby” shall be inserted in lieu thereof.”

More on “covered by the Section 3(d) Representation”

We went digging a little deeper. These are the only examples we could find before we got bored looking. In each case we are not persuaded these caveats accommodate anyone other than our value-adding learned friends:

Legal opinions

Should a legal opinion issued by a third party who is not party to the agreement, or even affiliated with it, have to be true in the Section 3(d) sense?

The predictable response is for the counterparty to say, “look: I’m not a lawyer, okay, so it can hardly be on me if the legal advice I get in good faith happens to be wrong?” We suppose this is excluded because the Party to the ISDA is not the author of the legal opinion, nor professionally competent to pass on its contents (hence the need for the legal opinion in the first place), so should hardly be expected to be held to account for it.

This may be expressed to you, dissonantly, in the honeyed prose of a private practice lawyer — a vernacular foreign to most ISDA negotiators. You may wonder whether it has not been disingenuously spoon-fed to your counterpart by just such a fellow. We will not speculate. But we will observe that, while it may seem compelling at first, it is bad logic. It presumes that what matters is the probity with which a counterparty conducts itself; that it acts in good faith and with a benign disposition; that its “good chapness” —the basic honesty it shows when dealing with its market counterparties — is beyond reproach.

But this, we submit, is to misunderstand in a profound way the point of a commercial contract. There are no ethicists in a foxhole. Unlike criminal or even tort law, the law of contract is not an instrument of moral judgment. It cares only about economics: that one does, or does not, do what one has promised or — as in this case — that what one has represented to you is, or is not, true. The law of contract is broadly incurious about why.

What matters is the economic consequence of a falsity — the actus reus, not one’s mens rea. The object of a legal opinion is to confirm the accuracy of a legal representation. Instead of simply representing that, for example, you have the regulatory permission to act as a swap dealer, you have a legal opinion to confirms that fact, from one who should know.

Now, if I have engaged in a trading arrangement with you on the presumption that you are appropriately permissioned, licenced, and constitutionally able to enter into valid and binding swap contracts, and you satisfy my qualms by proffering the legal opinion of some respectable attorney-about-town you have found who will say it is so, and that attorney turns out to be wrong, my commercial position is no less parlous just because you weren’t to know your legal advisor was a clot. Regardless of whose fault it was, or how egregious was her negligence in being at fault, if the required regulatory permission does not exist, the comfort I seek is misplaced. I now have a portfolio of swaps which may not be enforceable. My claims may be suspended at any minute.

I want out before that can happen. I might wish you well, and bitterly regret it were not otherwise, but it is not otherwise. I need out. If that causes you some embarrassment, inconvenience or financial loss, then the person to whom you should look for redress is your lawyer.

Not for the first time, the “market standard,” for no reason other than it is a legal question and there is no-one else around qualified to gainsay it, is crafted to suit the personal interests of the opining legal community. Have no truck with this, fellows.

Credit Support Documents

We imagine here the perceived fear is that a Credit Support Document, being an executed legal contract, does not have a truth or falsity independent of itself the bargain it represents and evidences, so cannot really be a misrepresentation. But in a funny sense a legal contract constitutes the agreement it evidences: sure; the legal accord is an immaterial, intellectual thing, a consensus ad idem that inhabits the incarcerated space that separates us, and it cannot be fully delimited by mortal, combustible paper. But all the same, its written form can hardly contradict it. If the written agreement incontrovertibly says “I must go up” our legal compact can hardly require me to go down; the paper format surely constrains what one can take from, or give to, a contract.

That being the case, there is not really a meaningful sense in which a contract can “misrepresent” the actual accord it represents. or be “false”. There is something faintly, but elusively, paradoxical about this.

What might happen is that a counterparty submits a form that has been superseded, or terminated and thus is but a husk of an ex-contract; one that once existed but now does not. Alternatively, a truly mendacious counterparty might offer up a form that is not really a contract, or even evidence of one, at all: a forgery, or a fraud.

But in those cases, the operating cause of the falsehood is the party submitting the document, not the document offered by way of representation itself, and in each an innocent party is better protected if Section 3(d) Representation does apply.

Audited financial statements

Your adversary may try to crowbar in something like this, to satisfy her yen to make a difference and please her clients with her acumen and commercial fortitude:

“or, in the case of financial information, a fair representation of the financial condition of the relevant party, provided that the other party may rely on any such information when determining whether an Additional Termination Event has occurred.”

This is predicated on the following reasoning: “In publishing the audit, the auditor itself is not making any greater representation than that the statements are a fair representation of the financial conditions. I’m no accountant. I didn’t even write the stupid audit. How am I supposed to know? Why should I give any representation about the content of the audit at all, let alone a stronger representation than the expert? I am not underwriting the work of some bean-counter at Deloitte.”

Fair questions, but they misapprehend what is being asked. The riposte is this: The Part 3 information you must supply is “Party B’s annual audited financial statements.” So the representation we are after is that you have handed over a fair, accurate and complete copy of those audited statements, not that the statements themselves, as prepared by the auditor, are necessarily fair, accurate and complete. To get that comfort, we have the auditor’s own representation of the company’s financial condition, and we don’t need yours.

Details

Not providing documents for delivery is an Event of Default ... eventually

The importance of promptly sending required documents for delivery goes as follows:

• By dint of Section 4(a) you agree to furnish each other Specified Information set out in Part 3 of the Schedule.
• By dint of Section 5(a)(ii) if you don’t then that can be a Breach of Agreement Event of Default (Section 5(a)(ii)). Be warned: you must pursue a tortured chain of nested double negatives and carefully parse the interplay between Sections 4(a) and 5(a)(ii) to grasp this, but it is true.
• But, Section 5(a)(ii) imposes a thirty freaking day grace period following notice before a Breach of Agreement counts as an Event of Default allowing termination. (A Failure to Pay or Deliver is excluded from that definition, by the way, because it has its own EOD with a much tighter grace period).
• So if you need a document “furnished” urgently and can’t wait a month for it (you might not, if you are a credit officer and it is a monthly NAV statement, for example) then you must upgrade a simple 5(a)(ii) Breach of Agreement to a full-blown Additional Termination Event.
  

Comparisons

No change between Section 3(e) of the 1992 ISDA and Section 3(e) of the 2002 ISDA. To be fair, what’s there to change?

Summary

You’ll find the usual form of the Payer Tax Representations in Part 2(a) of the Schedule. They aren’t usually amended.

Withholding under the ISDA

TL;DR: The basic rationale is this:

• if the tax relates to the underlying instrument, rather than the Payer’s residence or tax status, the Payer does not have to gross up.
• if the tax relates to the Payer’s residence or tax status, then the Payer does have to gross up unless the Payee should have provided information to the Payer which would have entitled the Payer to avoid the tax.
• if you’ve agreed the FATCA Amendment, the Payer doesn’t have to gross up any FATCA Withholding Taxes.

The combination of the Payer Tax Representations and the Gross-Up clause of the ISDA Master Agreement has the following effect:

• Section 3(e): I promise you that I do not have to withhold on my payments to you (as long as all your Payee Tax Representations are correct and you have, under Section 4(a), given me everything I need to pay free of withholding);
• Section 2(d): I will not withhold on any payments to you. Unless I am required to by law. Which I kind of told you I wasn’t... If I have to withhold, I'll pay the tax the authorities and give you the receipt. If I only had to withhold because of my connection to the taxing jurisdiction (that is, if the withholding is an Indemnifiable Tax), I’ll gross you up. (You should look at the drafting of Indemnifiable Tax, by the way. It's quite a marvel). ...
• Gross-Up: Unless the tax could have been avoided if the Payee had taken made all its 3(f) representations, delivered all its 4(a) material, or had its 3(f) representations been, like, true).
• Stamp Tax is a whole other thing.
• As is FATCA, which (as long as you’ve made your FATCA Amendment or signed up to a FATCA Protocol, provides that FATCA Withholding Taxes are excluded from the Section 3(e) Payer Tax Representations, and also from the definition of Indemnifiable Tax. Meaning one doesn't have to rep, or gross up, FATCA payments.
  

Comparisons

No change between the 1992 ISDA and the 2002 ISDA.

Summary

US Payee Tax Representations

The required Payee Tax Representations depend on the nature of the Counterparty.

• US Person: Counterparty is a “U.S. person” for the purposes of the Internal Revenue Code of 1986 as amended.
• US Corporation: It is classified as a US Corporation for United States federal income tax purposes.
• Foreign Person: It is a “foreign person” for United States federal income tax purposes.
• Non-US Branch of Foreign Person: Each branch is a non-US branch of a foreign person for US federal income tax purposes
• Non-Withholding Partnership:It is classified as a “non-withholding foreign partnership” for United States federal income tax purposes.
• Connected Payments: Each payment received or to be received by it under this Agreement will be effectively connected with its conduct of a trade or business within the United States.
• Non-Connected Payments: Each such payment received or to be received by it in connection with this Agreement will not be effectively connected with its conduct of a trade or business in the United States
• Tax Treaty Benefits: It is fully eligible for the benefits of the “Business Profits” or “Industrial and Commercial Profits” provision, the “Interest” provision or any “Other Income” provision of the Income Tax Convention between the United States and Counterparty’s Jurisdiction* with respect to any payment described in such provisions and received or to be received by it in connection with this Agreement and no such payment is attributable to a trade or business carried on by it through a permanent establishment in the United States.
• Public International Organisation: It is a public international organization that enjoys the privileges, exemptions and immunities as an international organization under the International Organizations Immunities Act (22 U.S.C. 288-288f).
• Withholding and Reporting: It will assume withholding and reporting for any payments (or portions of any payments) determined to be non-Effectively Connected income for United States federal income tax purposes.
• Monetary Policy: Its primary purpose for entering into this Agreement is to implement or effectuate its governmental, financial or monetary policy.
  

General discussion

Template:M gen 2002 ISDA 3(f)

Details

MI by 2002

PART II: SECTION 5 DEFAULT AND EARLY TERMINATION

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PART III: SECTION 6 CLOSE OUT

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Comparisons

Updated in 2002 with special pleadings relating to the newly-introduced Force Majeure Termination Event.

Summary

Note the difficulty of practical compliance with this provision, given a sizeable ISDA portfolio, and the requirement for actively monitoring not only standard Termination Events, but also Additional Termination Events, which may be counterparty or even Transaction-specific.

Be aware of the notices provision of the ISDA Master Agreement, especially if you’re using a 1992 ISDA and you were thinking of serving by email — NatWest Bank could tell you a thing or two about that, as this lengthy article explains — or if the world happens to be in the grip of madness, hysteria, pandemic or something equally improbable like an alien invasion.

Section 6(b)(i): Notice

It starts off gently. If you are subject to a Termination Event — remember these are generally extraneous things beyond your control like Tax Events, Illegality, Force Majeure, for which you can’t really be blamed, but which affect your capacity to efficiently perform the agreement, so this is nothing really to be ashamed about, even though it might colour your counterparty’s view of carrying on — you must notify your counterparty.

Comparisons

Note in the 2002 ISDA there is no reference to Illegality (or for that matter Force Majeure, which did not exist under the 1992 ISDA but tends to treated rather like a special case of Illegality and therefore, we think, would have been included in this provision of the 1992 ISDA if it had existed ... if you see what I mean).

When the 2002 ISDA gets on to the topic of Illegality and Force Majeure it allows the Unaffected Party to cherry-pick which Affected Transactions it will terminate, but then seems almost immediately to regret it (see especially in Section 6(b)(iv)). Under the 1992 ISDA if you wanted to pull the trigger on any Termination Event, you had to pull all Affected Transactions. Under the 2002 ISDA it is only binary for the credit- and tax-related Termination Events.

Otherwise, but for one consequential change — 1992’s “excluding” became 2002’s “other than” — I mean, you can just imagine the barney they must have had in the drafting committee for that one, can’t you — the provisions are identical.

Summary

Once the Waiting Period expires, it will be a Termination Event entitling either party to terminate some or all Affected Transactions. Partial termination is permitted because the impact on an event on each Transaction may differ from case to case (eg transactions forming part of a structured finance deal like a repack or a CDO) might not be easily replaced, so the disadvantages of terminating may outweigh the advantages.

As far as branches are concerned this is relatively uncontroversial, especially if yours is a multi-branch ISDA Master Agreement. But there is an interesting philosophical question here, for, without an express pre-existing contractual right to do so, a party may not unilaterally transfer its obligations under a contract to someone else. That, being a novation, requires the other party’s consent. This is deep contractual lore, predating the First Men and even the Children of the Woods. So if the Affected Party identifies an affiliate to whom it can transfer its rights and obligations, the Non-affected Party still may withhold consent. True, it is obliged to provide consent if its policies permit but — well — y’know. Polices? Given the credit department’s proclivities for the fantastical, it’s a fairly safe bet they’ll be able to find something if they don’t feel up to it.

That is to say, this commitment falls some wat short of the JC’s favourite confection: “in good faith and a commercially reasonable manner”.

Note also that if an Non-Affected Party does elect partial termination, the Affected Party has the right to terminate some or all of the remaining Transactions: this prevents Non-Affected Parties being opportunistic. Heaven forfend.

Section 6(b)(ii): Transfer to Avoid Termination Event

Things start to go a bit wobbly. You sense that ISDA’s crack drafting squad™ has been on the sauce, or marching powder or something, and became attached to the idea of trying to codify the unknowable future. It gets worse before it gets better but here the permutations are about the parties tax status: either the Tax law has changed for one or other party — a Tax Event — or a party has executed some fancy cross-border merger which has somehow changed its tax residence, status, or eligibility of favourable tax treatment: this is a Tax Event Upon Merger. Here, in essence, you have a little window to sort yourself out, if you hadn’t done that before the merger (isn’t that what Tax advisors are for, by the way?).

Tax Event Upon Merger is also apt to create magnificent rounds of three-dimensional ninja combat drafting, because there is an Affected Party, and a Burdened Party, and they are not ~ necessarily ~ the same, and that is even before you worry about what has happened if there is a Credit Event Upon Merger (could be, right? There is a merger... so why not?) and/or a Force Majeure going on at the same time.

In any case: the Affected Party of a simple Tax Event, or the Affected Party of a TEUM who is also the Burdened Party must try doggedly for twenty days to transfer its rights and obligations to an unaffected Office or Affiliate before it is allowed to trigger an Early Termination Date. In any case the innocent, Unaffected Party, has a varnished right to decline the transfer if it can’t trade with the designated transferee.

Comparisons

Note in the 2002 ISDA there is no reference to Illegality (or for that matter Force Majeure, which did not exist under the 1992 ISDA but tends to treated rather like a special case of Illegality and therefore, we think, would have been included in this provision of the 1992 ISDA if it had existed ... if you see what I mean).

When the 2002 ISDA gets on to the topic of Illegality and Force Majeure it allows the Unaffected Party to cherry-pick which Affected Transactions it will terminate, but then seems almost immediately to regret it (see especially in Section 6(b)(iv)). Under the 1992 ISDA if you wanted to pull the trigger on any Termination Event, you had to pull all Affected Transactions. Under the 2002 ISDA it is only binary for the credit- and tax-related Termination Events.

Otherwise, but for one consequential change — 1992’s “excluding” became 2002’s “other than” — I mean, you can just imagine the barney they must have had in the drafting committee for that one, can’t you — the provisions are identical.

Summary

Once the Waiting Period expires, it will be a Termination Event entitling either party to terminate some or all Affected Transactions. Partial termination is permitted because the impact on an event on each Transaction may differ from case to case (eg transactions forming part of a structured finance deal like a repack or a CDO) might not be easily replaced, so the disadvantages of terminating may outweigh the advantages.

As far as branches are concerned this is relatively uncontroversial, especially if yours is a multi-branch ISDA Master Agreement. But there is an interesting philosophical question here, for, without an express pre-existing contractual right to do so, a party may not unilaterally transfer its obligations under a contract to someone else. That, being a novation, requires the other party’s consent. This is deep contractual lore, predating the First Men and even the Children of the Woods. So if the Affected Party identifies an affiliate to whom it can transfer its rights and obligations, the Non-affected Party still may withhold consent. True, it is obliged to provide consent if its policies permit but — well — y’know. Polices? Given the credit department’s proclivities for the fantastical, it’s a fairly safe bet they’ll be able to find something if they don’t feel up to it.

That is to say, this commitment falls some wat short of the JC’s favourite confection: “in good faith and a commercially reasonable manner”.

Note also that if an Non-Affected Party does elect partial termination, the Affected Party has the right to terminate some or all of the remaining Transactions: this prevents Non-Affected Parties being opportunistic. Heaven forfend.

Section 6(b)(ii): Transfer to Avoid Termination Event

Things start to go a bit wobbly. You sense that ISDA’s crack drafting squad™ has been on the sauce, or marching powder or something, and became attached to the idea of trying to codify the unknowable future. It gets worse before it gets better but here the permutations are about the parties tax status: either the Tax law has changed for one or other party — a Tax Event — or a party has executed some fancy cross-border merger which has somehow changed its tax residence, status, or eligibility of favourable tax treatment: this is a Tax Event Upon Merger. Here, in essence, you have a little window to sort yourself out, if you hadn’t done that before the merger (isn’t that what Tax advisors are for, by the way?).

Tax Event Upon Merger is also apt to create magnificent rounds of three-dimensional ninja combat drafting, because there is an Affected Party, and a Burdened Party, and they are not ~ necessarily ~ the same, and that is even before you worry about what has happened if there is a Credit Event Upon Merger (could be, right? There is a merger... so why not?) and/or a Force Majeure going on at the same time.

In any case: the Affected Party of a simple Tax Event, or the Affected Party of a TEUM who is also the Burdened Party must try doggedly for twenty days to transfer its rights and obligations to an unaffected Office or Affiliate before it is allowed to trigger an Early Termination Date. In any case the innocent, Unaffected Party, has a varnished right to decline the transfer if it can’t trade with the designated transferee.

Comparisons

Oh, this section 6(b)(iv) stuff
Is sure stirring up some ghosts for me.
She said, “There’s one thing you gotta learn
Is not to be afraid of it.”
I said, “No, I like it, I like it, it’s good.”
She said, “You like it now —
But you’ll learn to love it later”

— Robbie Robertson

One’s right to terminate early following an Illegality or the newly introduced Force Majeure Termination Event get a proper makeover in the 2002 ISDA, but otherwise, the provisions are the same, but for some formal fiddling in the drafting.

Summary

What a beast. If you track it through in Nutshell™ terms, it isn’t as bad as it looks, but you have the ISDA ninja’s gift for over-complication, and ISDA’s crack drafting squad™’s yen for dismal drafting, to thank for this being the trial it is.

To make it easier, we’ve invented some concepts and taken a few liberties:

“Unaffected Transaction”, which saves you all that mucking around saying “Transactions other than those that are, or are deemed, to be Affected Transactions” and so on;

Termination Event Notice: An elegant and self-explanatory alternative to “after an Affected Party gives notice under Section 6(b)(i)”.

We take it as logically true that you can’t give 20 days’ notice of something which you then say will happen in fewer than 20 days. Therefore, there is no need for all this “designate a day not earlier than the day such notice is effective” nonsense.

So with that all out the way, here is how it works. Keep in mind that, unlike Events of Default, Termination Events can arise through no fault of the Affected Party and, therefore, are not always as apocalyptic in consequence. Depending what they are, they may be cured or worked-around, and dented Transactions that can’t be panel-beaten back into shape may be surgically excised, allowing the remainder of the ISDA Master Agreement, and all Unaffected Transactions under it, to carry on as normal. So here goes:

Divide up the types of Termination Event

Tax ones: If a Tax Event or a TEUM where the party merging is the one that suffers the tax, the parties have a month to try to rearrange matters between them, their offices and affiliates to avoid the tax issue. Only once that has failed are you in Termination Event territory. See Section 6(b)(ii) and 6(b)(iii).

Non-Affected Party ones: If it’s a CEUM, an ATE or a TEUM where the Non-Affected Party suffers the tax, then if the other guy is a Non-Affected Party, then (whether or not you are) you may designate an Early Termination date for the Affected Transactions.

Illegality and Force Majeure: Here, if you are on a 2002 ISDA, there may be a Waiting Period to sit through, to see whether the difficulty clears. For Force Majeure Event it is eight Local Business Days; for Illegality other than one preventing performance of a Credit Support Document: three Local Business Days. So, sit through it. Why is there exception for Illegality on a Credit Support Document? Because, even though it wasn’t your fault, illegality of a Credit Support Document profoundly changes your credit assessment (in a way that arguably, even a payment or delivery obligation doesn’t), and that is the most fundamental risk you are managing under the ISDA Master Agreement.

General discussion

Template:M gen 2002 ISDA 6(b)(iv)

Details

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==PART IV: BOILERPLATE MI by 2002
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