User talk:Amwelladmin

From The Jolly Contrarian
Jump to navigation Jump to search


Section Preamble

Section Preamble in a nutshell

2002 ISDA Master Agreement


between


[SPECIFY] and [SPECIFY]


will be entering into “Transactions” governed by this 2002 Master Agreement and its “Schedule”, and a “Confirmation” evidencing those Transactions. The 2002 Master Agreement with its Schedule are the “Master Agreement”.
So:―

Comparison between versions

Little material difference between the 1992 ISDA and the 2002 ISDA here. ISDA’s crack drafting squadTM being, by 2002, a more world-weary, battle-hardened combat unit than it was in 1992, was more alive in the 2002 ISDA to the idea that one might confirm Transactions other than via a full-blown Confirmation: those with master confirmation agreements and who match commoditised swap transactions through online trade matching systems may appreciate this acknowledgement, but it still falls in the circular “goes without saying” filing cabinet in this commentator’s opinion.

Discussion

The preamble, which talks in somewhat laboured terms about the architecture of the ISDA contract, is the only place in the ISDA Master Agreement where the concept of the “Transaction” — being the actual swaps you put on under one of these confounded agreements — is defined.

ISDA architecture

The legal documentation for an ISDA swap transaction comes in three main parts, but — of course — there are complications for the legal eagles to get their iatrogenic talons into. But for now, let’s start at the beginning.

The ISDA Master Agreement

The ISDA Master Agreement is the basic framework which applies to anyone who touches down on planet ISDA. There are three existing versions:

  • the state-of-the-art 2002 ISDA;[1]
  • the still-popular-with-traditionalists-and-Americans 1992 ISDA, and
  • the all-but-retired-but-don’t-forget-there-are-still-soldiers-in-the-Burmese-jungle 1987 ISDA[2]
  • the interesting-only-for-its-place-in-the-fossil-record-and-witty-acrostic 1985 ISDA Code; and
  • there isn’t a 2008 ISDA. That’s a little running JC in-joke.[3]

All three versions have a tri-partite form: Pre-printed Master, Schedule and — well, this is controversial: for is it, or is it not, part of the ISDA Master Agreement? — Credit Support Annex.

Pre-printed master

The first part of the trinity is the pre-printed form of ISDA Master Agreement.

  • Content: The ISDA Master Agreement has 14 “Sections” and is inviolate. It doesn’t have much to say about any particular Transaction, but just assumes you will be entering lots of them, and provides for general terms that apply to all of them. So, Representations, covenants to maintain certain standards and supply credit information, and critically Events of Default, Termination Events, and Close-out rights. Close-out is deep ISDA lore: this is what almost all of the excitement in an ISDA negotiation is about, and there will be much more to say about it later.
  • You don’t edit it: You don’t, despite the darkest fears of your internal audit department, ever edit this document. Ever. This is by quite deliberate design. Everyone in the market knows the ISDA intimately, and there is good comfort in knowing, when it comes to that terrible moment when, as the world goes to hell, you have to understand your rights and obligations, that you don't have to read the 19 pages of the pre-print as well. Even the pagination and line-layout is sacrosanct: Some connoisseurs cherish the Schedule amendment which purports to excise “the third word of the second line of limb (b) of Section 5(a)(viii)”. Honestly. The ISDA Master Agreement’s generally a .pdf, so you can’t[4] but, in any weather, you don’t.[5] You just don’t.
  • You do amend it: But, of course, an ISDA Master Agreement is nothing without a long and pointless negotiation to amend, augment or clarify this agreement! And to be sure you can amend an ISDA, but you do this is by providing for an amendment in your ...

ISDA Schedule

This overlays the pre-printed master agreement. Here you specify Additional Termination Events, add economic variables, names, addresses, add Tax Representations and then, in Part 5, you are free to make any technical amendments your credit and legal chicken lickens want for the avoidance of doubt, and that you couldn't make because technical ineptitude and unerring market convention prevented you editing the preprinted master. That comprises your overarching ISDA Master Agreement, though you may also have a ...

Credit support arrangement

The credit support arrangement usually takes the form of an annex to the ISDA Master Agreement. It may be under English law or New York law. The English law CSA has 11 “Paragraphs”; the 1994 New York law CSA — which has fiddly and rather pointless security provisions — has 13, in each case the last one being an editable schedule of Elections and Variables. Like the ISDA Master Agreement you don’t edit the pre-printed Paragraphs. Now in order to document a specific Transaction you will need a...

Confirmation

The Confirmation is the thing that actually documents a specific swap Transaction. This you can edit, to your heart’s content. There is sometimes an intermediate Master Confirmation Agreement which documents the generic terms for all, say equity derivative Transactions. Template:M detail 2002 ISDA Preamble

Section 1

Section 1 in a nutshell

1. Interpretation

1(a) Definitions. Most of the definitions are in Section 14 but some are scattered throughout the Master Agreement.
1(b) Inconsistency. Where they conflict, each Confirmation overrides the Schedule, and the Schedule overides the Master Agreement.
1(c) Single Agreement. When they enter each Transaction the parties are relying on the Master Agreement and all outstanding Confirmations being a single agreement. They would not otherwise enter into any Transaction.

Comparison between versions

But for some refreshing loosie-goosiness in the 2002 ISDA about where one might otherwise define terms, the text of Section 1 is the same in each version of the ISDA Master Agreement.

Discussion

Section 1 is a gentle introduction indeed to the dappled world of the ISDA Master Agreement: much coming from the “goes without saying, but let’s say it anyway” dept of legal wordwrightery — a large department indeed, in the annals of modern legal practice. It starts getting a bit tasty in Section 1(c) with the Single Agreement, but it’s not until the Section 2(a)(iii) flawed asset provision that you’re properly in the ISDA ninja twilight zone.

In a nutshell: DO NOT ADJUST THIS PROVISION. It does no-one any harm. How could it?

Section 1(c): the Single Agreement

Most of Section 1 may be theatrical throat-clearing, but section 1(c) is important — by some lights, the main reason one even has an ISDA Master Agreement: it vouchsafes your close-out netting analysis, purporting to inextricably bind together all Transactions under the ISDA Master Agreement as part of a single, concerted, nettable whole. Should (God forbid) your counterparty have imploded, an unthinking administrator might feel the three-year jet fuel swap you traded in July 2012 had nothing really to do with your six-month interest rate swap from February last year and when it comes to considering who owes who what, the two should be treated as separate, unitary transactions. It might think this quite enthusiastically if one of those transactions happens out-of-the-money to you, and the other one in-the-money. This, at any rate, has been the dominant fear of the Basel Committee on Bank Supervision since it hit upon the idea of capital relief for master netting agreements in 1986.

“Why, that’s dashed bad luck, old man! You have to pay me that out-of-the-money exposure[6] and while this dead parrot owes you on the other trade, the end of the creditors’ queue is that one you can see over there in the far distance, should you have a telescope on you.”

You might be inclined to say, “but wait: we should be able to set these off surely! This is all the same stuff, right! Swaps! They all go together! They’re not unitary transactions at all!”

Well, Section 1(c) — the one that says “it is all a single agreement, and we would never have done any of this if we had thought for a moment it might not be, and to prove it we are saying this out loud at the very inception of our derivatives relationship” is your friend in making that argument. There are similar provisions in other agreements, but none is so classic or elegant as the ISDA Master Agreement’s.

Assignment and its effect on Netting and Set-off

Could a right to assign by way of security upset close-out netting such that one should forbid parties making assignments by way of security of their rights under the ISDA Master Agreement, for fear of undermining your carefully organised netting opinions?

Generally: No.

  • An assignment by way of security is a preferred claim in the assignor’s insolvency over the realised value of certain rights the assignor holds against its counterparty. It is not a direct transfer of those rights to an assignee: the counterparty is still obliged to the assignor, not the assignee, and any claim the assignee would have against the counterparty would only be by way of subrogation of the assignor’s claim, should the assignor have imploded in the meantime or something.
  • Nemo dat quod non habet”:[7] the unaffected counterparty’s rights cannot be improved (or worsened) by assignment and, it being a single agreement, on termination of the agreement the assignee’s claim is to the Termination Amount determined under the ISDA Master Agreement, which involves terminating all Transactions and determining the aggregate mark-to-market and applying close-out netting. No one can give what they do not have.[8]

At the point of close-out, the assignee’s right is to any Termination Amount payable to the Counterparty. Therefore any assignment of rights is logically subject to the netting, as opposed to potentially destructive of it.

But: This is only true insofar as your netting agreement does not actively do something crazy, like disapplying netting of receivables which have been subject to an assignment and dividing these amounts off as “excluded termination amounts not subject to netting”. I know what you are thinking. “But why on God’s green earth would anyone do that?” This is a question you might pose to the FIA’s crack drafting squadTM, who confabulated the FIA’s Professional Client Agreement, which does exactly that.

Happily, ISDA’s crack drafting squadTM was never quite so cavalier with the ISDA Master Agreement, though.

Section 2

Section 2 in a nutshell

2. Obligations

2(a) General Conditions.

2(a)(i) Each party must perform its obligations under each Transaction Confirmation.
2(a)(ii) Parties must make:
(a) Payments for value the due date, as specified in the Confirmation, in freely transferable funds and in the regular fashion for making payments in the currency in question.
(b) Deliveries for receipt on the due date and in the regular fashion for making deliveries of the asset in question.
2(a)(iii) Each party’s obligations under Section 2(a)(i) are subject to the following conditions precedent:
(1) there is no existing Event of Default or Potential Event of Default against the other party;
(2) no Early Termination Date has been designated for the Transaction in question
(3) each other condition precedent in this Agreement.

2(b) Change of Account. Either party may change its standard settlement instructions by five Local Business Days’ notice before any Scheduled Settlement Date but the other party may make reasonable objections to such a change.
2(c) Netting of Payments. If on any date amounts would otherwise be payable by each party to the other

(i) in the same currency; and
(ii) under the same Transaction,

then those obligations will be satisfied and replaced by an obligation on the party owing the larger amount to pay the difference. The parties may net payments across multiple specified Transactions by applying “Multiple Transaction Payment Netting” (and clause 2(c)(ii) will therefore not apply). Multiple Transaction Payment Netting arrangements may apply to different groups of Transactions, will apply separately to each pairing of specified Offices and will take effect as agreed between the parties.
2(d) Deduction or Withholding for Tax.

2(d)(i) Gross-Up. The parties must pay without withholding unless required by law. Where a payer has to withhold, it must:—
(1) promptly tell the recipient;
(2) promptly pay the withheld amount to the relevant authorities (including the withholding on any required gross-up);
(3) give the recipient a receipt for the tax payment; and
(4) gross up any Indemnifiable Tax, so that the recipient receives the amount it would otherwise have received (free of Indemnifiable Taxes). However, the payer need not gross up any withholding that arose only because:—
(A) the recipient did not provide Section 4(a) tax information, or breached its Payee Tax Representations; or
(B) the recipient's Payee Tax Representations were not true (other than because of regulatory action taken after execution of the Transaction or a Change in Tax Law.
2(d)(ii) Liability. If the payer :—
(1) is required by law to withhold a non-Indemnifiable Tax;
(2) nonetheless does not do so; and
(3) suffers by direct assessment a liability for that Tax,
then, unless the recipient has satisfied the Tax liability directly, it must reimburse the payer for that liability (plus interest, but not penalties unless it failed to provide tax information required under Section 4(a), or breached any Payee Tax Representations.

Comparison between versions

2 Obligations

2(a) General Conditions, including the famous Section 2(a)(iii)
2(b) Change of Account
2(c) Netting
2(d) Deduction of Witholding for Tax

Readers looking for significant differences between the 1992 ISDA and 2002 ISDA will find their socks resolutely still on by the time they get to the end of section 2. Other than some new Multiple Transaction Payment Netting wording designed to untangle a cat’s cradle of language that, in this commentator opinion, didn’t need to be there in the first place, the only significant change in Section 2 is that the Default Interest provision has been removed and now appears, in a gruesomely reorganised format, in Section 9(h) of the 2002 ISDA.

Discussion

Section 2(a) contains the fundamental payment and delivery obligations under the ISDA Master Agreement; the remainder of the section is a random collection of harmless and uncontroversial, or even unnecessary, bits of housekeeping such as how one changes settlement instructions (Section 2(b)), under what circumstances the parties can next down offsetting payments in the ordinary course (Section 2(c) — though, spoiler, whenever they both feel like it), and arrangements for where and when one grosses up for withholding tax is (Section 2(d)). Template:M gen 2002 ISDA 2 Template:M detail 2002 ISDA 2

Subsection 2(a)

Comparison between versions

Section 2(a) is identical in the 1992 ISDA and the 2002 ISDA.

Discussion

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.

And then there’s the mighty flawed asset provision of Section 2(a)(iii). This won’t trouble ISDA negotiators on the way in to a swap trading relationship — few people argue understand it enough to argue about it — but if, as it surely well, the great day of judgement should visit upon the financial markets again some time in the future, expect plenty of tasty argument, between highly-paid Queen’s Counsel who have spent exactly none of their careers considering derivative contracts, about what exactly it means. 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”. Template:M detail 2002 ISDA 2(a)

Subsection 2(a)(iii)

Comparison between versions

Section 2(a)(iii) is the world-famous, notorious, much-feared flawed asset provision in the ISDA Master Agreement. Fertile hunting grounds for fee-hungry barristers in the Re Lehman Brothers International and Re Spectrum Plus litigations.

Discussion

Flawed assets generally

Following an event of default, a “flawed asset” provision allows an innocent, but out-of-the-money counterparty to a derivative or securities finance transaction to suspend performance of its obligations without terminating the transaction and thereby crystallising a mark-to-market loss.

The asset – a right to payment under the transaction – is “flawed” in the sense that it only become payable if the conditions precedent to payment are fulfilled.

The most famous flawed asset clause is Section 2(a)(iii) of the ISDA Master Agreement. It entered the argot in a simpler, more peaceable time, when two-way, zero-threshold, daily margined CSAs were a rather fantastical sight, and it was reasonably likely that a counterparty might be nursing a large unfunded mark-to-market liability which it would not want to have to fund just because the clot at the other end of the contract had gone belly-up. Closing out the contract would crystallise that liability, so the flawed asset provision allowed that innocent fellow to just stop performing hte contract altogether, rather than paying out its mark-to-market loss.

That was then; 1987; they hadn’t even invented the 1995 English Law CSA. Even once they had, it would be common for a muscular broker/dealers to insist on one-way margining: “You, no-name pipsqueak highly levered hedge fund type, are paying me variation margin and initial margin; I, highly-capitalised, prudentially regulated, balance-sheet levered[9] financial institution, am not paying you any margin.”

Well, those days are gone, and bilateral zero-threshold margin arrangements are more or less obligatory nowadays, so it’s hard to see the justification for a flawed asset provision. But we still have one, and modish post-crisis threats by regulators worldwide to stamp them out seem, some time in 2014, to have come to a juddering halt.

Why the regulators don’t like Section 2(a)(iii)

While not concluding that 2(a)(iii) is necessarily a “walk-away clause” (or an “ipso facto” clause, as it is called in the US) UK regulators were concerned after the financial crisis that Section 2(a)(iii) could be used to that effect and wondered aloud whether such practices should be allowed to continue. Why? Because you are kicking a fellow when he is down, in essence.

An insolvent counterparty may be in a weakened moral state, but if it still made some good bets under its derivative trading arrangements, so it ought to be allowed to realise them. On the other hand, the contract has a fixed term; you wouldn’t be entitled to realise those gains early if you hadn’t gone insolvent[10] so why should it be any different just because you’ve blown up? The answer to that is, put up or shut up: If you don’t like it that I can’t pay your margin, you are entitled to close out. If you don’t want to close out, then you can jolly well carry on performing. In any case, regulators also wonder: how long can this state of suspended animation last? Indefinitely? What is to stop a non-defaulting party monetising the gross obligations of a defaulting party not closing out, invoking 2(a)(iii), suspending its performance and then realising value by set-off?

On the other hand, suggesting a fundamental part of the close-out circuitry of an ISDA Master Agreement is a "walk-away" takes prudentially regulated counterparties to an uncomfortable place with regard to their risk-weighted assets methodology.

With the effluxion of time some of the heat seems to have gone out of the debate, and new policies, or market-led solutions, have taken hold.

Litigation

There is a (generous) handful of important authorities on the effect under English law or New York law of the suspension of obligations under Section 2(a)(iii) of the ISDA Master Agreement, and whether flawed asset provision amounts to an “ipso facto clause” under the US Bankruptcy Code or violates the “anti-deprivation” principle under English law. These are amusing, as they are conducted in front of judges and between litigators none of whom has spent more than a fleeting morning in their professional careers considering the legal complications, let alone commercial implications, of derivative contracts. Thus, expect some random results[11].

Enron v TXU upheld the validity of Section 2(a)(iii)[12] Metavante v Lehman considered Section 2(a)(iii) of the ISDA Master Agreement and reached more or less the opposite conclusion.

Also of interest in the back issues of the Jolly Contrarian’s Law Reports are:

Template:M detail 2002 ISDA 2(a)(iii)

Subsection 2(b)

Comparison between versions

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

Discussion

ISDA’s crack drafting squadTM phoning it in, I’m obliged to say, and not minded to make any better a job of it when given the opportunity in 2002.

One can (and — cough — does) accuse finance lawyers of a yen for over-determinism in their drafting: no contingency, however remote or commercially obtuse, is left unaddressed, for fear of the consequences should it come about and the parties not find it in themselves to act like sentient adults and figure it out between them.

And what happens if the recipient makes a “reasonable objection”, and for that matter what could such a “reasonable objection” conceivably be?

Who can say?

ISDA’s crack drafting squadTM got to the edge of the cliff — it tacitly realises your counterparty might do something stupid, like changing its address for notices to a rural delivery run off the grid in the Sudan — but couldn’t be bothered to dream up a way out if it does.

Yet, curiously, in almost thirty years the Queen’s Bench Division has not been called on to arbitrate on who should give way in the event of such an impasse.

Odd, that. Template:M gen 2002 ISDA 2(b) Template:M detail 2002 ISDA 2(b)

Subsection 2(c)

Comparison between versions

Settlement netting, not close-out netting

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 close-out netting, see here:

Discussion

I mean, what is the point?

Our chief contrarian wonders what on earth 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 in different way.

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 actually happened, so what do you think you’re going to court to enforce?

So, friends, this rather convoluted passage in that mighty industry standard is, as G. K. Chesterton once said - merely piss and wind.

Multiple Transaction Payment Netting

Multiple Transaction Payment Netting” is a defined term introduced in the 2002 ISDA in place of the more clunky 1992 ISDA language set out in Section 2(c).

In the 1992 ISDA, to specify that netting across transactions would apply, you must disapply Section 2(c)(ii). Counterintuitive, but true (because otherwise netting only applies in respect of the same Transaction).

That is partly why, in the 2002 ISDA they introduced the more intuitive Multiple Transaction Payment Netting concept. So now you can say “Multiple Transaction Payment Netting does (or does not) apply”.

Of course, the one person who is going to have no clue — or, for that matter, care — about how transaction netting works at an operational level is negotiator expected to thrash this out in the document.

Now, seeing as (per above) payment netting is an operational fact not a legal right as such, and it doesn’t need to be in the contract, and your negotiator will care not one row of buttons whether or not Multiple Transaction Payment Netting, or its 1992 predecessor, applies or not, you might think it wise to put something diffident like “The parties will agree to any Multiple Transaction Payment Netting arrangements separately as an operational matter.”

I know, I know: I’m a total Mr. Buzzkill. But look, it’s for the good of your own long-term mental health.

Relevance of Section 6 to the peacetime operation of the 1995 English Law CSA

The calculation of Exposure under the 1995 English Law CSA is modelled on the Section 6(e)(ii) termination methodology following a Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.

This means you calculate the Exposure as:

(a) the Close-out Amounts for each Terminated Transaction plus
(b) Unpaid Amounts due to the Non-defaulting Party; minus
(c) Unpaid Amounts due to the Defaulting Party.

This is interesting because, as of its Termination Date the Transaction may be no more, but until those final exchanges are settled the obligations they represent — “Unpaid Amounts” in the argot of Section 6(e) — still exist and are included in the calculation of the Exposure.

Now, on the day you are meant to make that final settlement, which when (ahem — if) settled, would reduce your Exposure, you will call for your Delivery Amount or Return Amount assuming it has not (yet) been paid. By the time the Credit Support adjustment has been settled, that final settlement will have happened, meaning the person who paid the adjustment will be out of pocket, and will need to call it back (using the same process).

Fun times in the world of collateral operations.

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:

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.
Template:M detail 2002 ISDA 2(c)

Subsection 2(d)

Comparison between versions

Observant and less obedient scholars will remark what a pig’s ear the ISDA drafting committee made of a simple concept and, when given a once-in-a-decade opportunity to improve it in 2002, the combined intellectual might of ISDA, its members, friends, relations and their divers counsel, retinue and entourage, couldn’t.

Or didn’t.

Both are excruciating in the conveyance of a fairly simple idea, which, in a NutshellTM is set out at the top of the panel on the right.

Discussion

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 covered elsewhere

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

Withholding under the ISDA

TL;DR: The basic rationale is this:

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.

Template:M gen 2002 ISDA 2(d) Template:M detail 2002 ISDA 2(d)

Section 3

Section 3 in a nutshell

3. Representations

Each party makes the representations below (with Section 3(g) representations only if specified in the Schedule) and repeats them on the date it enters into each Transaction and, for Section 3(f) representations, at all times until they terminate this Agreement). Any “Additional Representations” will be made and repeated as specified.
3(a) Basic Representations

3(a)(i) Status. It is duly organised and validly existing under the laws of its jurisdiction and is, where relevant, in good standing;
3(a)(ii) Powers. It has the power to execute, deliver and perform this Agreement and any Credit Support Document to which it is a party and has done everything needed to do so;
3(a)(iii) No Violation or Conflict. Its execution, delivery and performance does not breach law, its constitutional documents, or any court or government order or contractual restriction affecting it or its assets;
3(a)(iv) Consents. It has all regulatory approvals needed to enter and perform this Agreement and any Credit Support Document to which it is a party and they remain unconditional and in full force; and
3(a)(v) Obligations Binding. Its obligations under this Agreement and any Credit Support Document to which it is a party are its legal, valid and binding obligations, enforceable in accordance with their terms (subject to general laws affecting creditors’ rights and equitable principles).

3(b) Absence of Certain Events. No Event of Default or Potential Event of Default or, to its knowledge, Termination Event is in existence for that party or would happen if it entered or performed this Agreement or any Credit Support Document.
3(c) Absence of Litigation. There is no pending or threatened litigation against it, any Credit Support Providers or any Specified Entities before any court or government agency that could affect the legality, enforceability or its ability to perform this Agreement or any Credit Support Document.
3(d) Accuracy of Specified Information. The Specified Information designated as being subject to this Section 3(d) representation is, as at its stated date, materially accurate and complete.
3(e) Payer Tax Representation. Each of its Payer Tax Representations specified in the Schedule is true.
3(f) Payee Tax Representation. Each Payee Tax Representation it has made to which this Section 3(f) applies (as specified in the Schedule) is true.
3(g) No Agency. It is a principal and not an agent under this Agreement.

Comparison between versions

3 Representations

3(a) Basic Representations
3(b) Absence of certain events
3(c) Absence of litigation
3(d) Accuracy of Specified Information
3(e) Payer Tax Representations
3(f) Payee Tax Representations
3(g) No Agency (2002 ISDA only)

Discussion

Misrepresentation is an Event of Default

A breach of any of these Representations when made (or deemed repeated) (except a Payer or Payee Tax Representation, but including any Additional Representation is an Event of Default.

Additional Representations as Additional Termination Events

In the case of Additional Representations this can be somewhat drastic, especially if your Additional Representation is Transaction-specific (for example India, China and Taiwan investor status reps for equity derivatives), and it would seem churlish to close out a whole ISDA Master Agreement on their account.

Then again, show me a swap dealer who would detonate an entire swap trading relationship with as solvent counterparty and I’ll show you a moron — but, as we know, opposing legal eagles operate on the presumption that everyone else is a moron and thus tend to be immune to such grand rhetorical flourishes, regard such appeals to basic common sense as precisely such flourishes, so don’t expect that argument to carry the day, however practically true it may be.

Instead, expect to encounter leagues of agonising drafting, but there are easier roads to travel. Try:

These representations will be Additional Representations, except that where they prove to be materially incorrect or misleading when made or repeated it will not be an Event of Default but an Additional Termination Event, where the Transactions in question are the Affected Transactions and the misrepresenting party is the sole Affected Party.

On representations and warranties generally

Representations

A representation is a statement of present fact made by one person which induces another to enter a contract. By its nature, a representation is therefore not a term of the contract itself — it cannot be; it was made before the contract came about; it is an egg to the contract’s chicken — although that won’t stop attorneys gleefully adding representations into the contract afterward, co-branding them as warranties, for good measure. For, if your counsel is diligent enough, you may have your cake and eat it, too. Non-contractual representations may provide relief: a false representation may entitle the party induced into the contract in reliance on it to claim under the Misrepresentation Act 1967 and rescind the contract altogether, or claim damages for negligent misstatement in tort.

Warranties

A warranty is a statement of a current fact made as a term of a contract. If a warrantor breaches its warranty the injured party might claim damages for the breach of contract and sue for damages, but cannot rescind it altogether. To set aside the contract as if it never happened — to void it, ab initio — you would need to prove a misrepresentation from someone before the contract, that induced you to enter it.

Purists would say that a “warranty” is no more suitable for a statement of future fact — if, epistemologically, such a thing is even a thing, and those same purists would say it is not — for who knows what the future brings? The common law is no hard determinist; the golden thread of precedent looks backward, not forward; the slings and arrows of outrageous fortune may yet pin us to a different hill. If the future is a soufflé, it is not so much that it hasn’t yet risen, but that the jurists who might be eating it have not yet decided whether they’re even going to that restaurant, and nor do they know whether it even has soufflé on the menu in the first place.

The thing the common law understands for making commitments which measure the world that’s yet to come is called a “promise” or, if you want to sound flash about it, an “undertaking”.

How material is “material”?

What is a “material” respect? This is key, since some of the general representations (Consents, for example) are quite wide, and in this world of regulatory perma-change, the risk that one is, for example, outside technical compliance with a new regulation as it is implemented, notwithstanding a competent regulator’s informal indication that no action will be taken if you get your skates on and remediate quickly — it happened for MiFID II as thousands of financial firms raced headlong at the brick wall of that 3 January 2017 implementation date[13] but it seems reasonable to suppose that materially must somehow impact your ability to carry out your obligations under a Transaction or the ISDA Master Agreement[14].

Additional Representations

The representations set out in Section 3 are, of course, the boring ones. The Additional Representations that are pulled in here and have the same effect on the Events of Default as do these boring ones — over which the parties will tortuously argue during the negotiation process, are lot more interesting — literary, really — reflecting as they do the dark paranoia lurking deep in the heart of your favourite credit officer.

And 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[15]? Do we think it works? Do we? Given how[16] 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.

Representations by investment managers and agents

There are those credit officers who will ask for representations from people who are not, strictly speaking, parties to the contract at all, even though they have a tremendous bearing on how it plays out. These are the investment managersinvestment advisors and hedge fund managers who act as agents on behalf of docile espievie funds in whom their investors buy shares.

You might, for example, want your manager to represent that it is a Qualified Professional Asset Manager able to represent the retirement aspirations of teachers in the Wisconsin Education board or some such thing. Such a QPAM’s declarations can’t really be Additional Representations per se, since the investment manager isn’t Party B at all, but if these are given in writing, then can be documents for delivery to which Section 3(d) can be applied. But if losing QPAM status is an Additional Termination Event for Affected Transactions, then query what value there is in having one more cudgel to beat a poor, innocent espievie that didn’t do anything wrong in the first place.

Subsection 3(a)

Comparison between versions

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.

Discussion

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 squadTM 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 English Law CSA is not a Credit Support Document, however much it might sound like one[17], 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?

Section 3(a)(i): Status

That basic, resting-state level of confidence we all want to have that the legal entity we are hoping to trade with is not, actually a figment of our imagination, has not sneakily been dissolved or somehow transmogrified into a non-material projection on an astral plane, and is up to date with its bills, audits financial statements and annual regulatory filings.

Some of these, nowadays, ought to be moderated by the existence of universal unique legal entity identifiers — to quote pub philosopher Des Carter, I have an LEI, therefore I am — though most, you would think would be better coming from your satisfaction that the folk in onboarding have actually done their job.

However you look at it, there remains a bit of an existential question afoot here. It quickly gets rather Cartesian. For if you are not sure whether the person to whom you are speaking is really there, then how will asking that person to confirm it help?

“Could you please tell me you exist?” sounds to these old ears like a cry for the kind of help the representations and warranties section of a legal contract is not, realistically, well positioned to provide.

And if they do, but it turns out they don’t, then what?

Section 3(a)(ii): Powers

Whether your counterparty is even constitutionally capable of entering into obligations of the type contemplated by your contract, is a question of its capacity (as to which see also ultra vires). In this day and age, capacity — once a rich source of legal paranoia — is largely a dead letter among commercial enterprises in sensible jurisdictions, but it is still a banana skin for municipal bodies and local governments. Even thirty years on, the words “Orange County” or “Hammersmith and Fulham council” will be enough to get buttocks clenching in your risk department.
Ultra vires is Latin for “beyond its powers”, a concern which crops up usually in the context of a corporation or governmental authority exceeding the powers and objects set out in its constitution or charter. It may also have some relevance to a Trust.

In that most valuable and intellectually rewarding pastime of checking a prospective combatantcounterparty’s capacity and authority, ultra vires is your principle concern should it not, after all, have the capacity to transact in your chosen kind of derivative.

These days ultra vires is a rather old fashioned notion as far as an ordinary corporation goes — in most sensible jurisdictions, the vicissitudes of the ultra vires rule for innocent, publicly spirited bystanders (like swap dealers), whose only concern is that an undertaking is prudently managing the financial exposures inherent in its business, have been largely obliterated by legislation, but it is still liable to induce butterflies in your team of legal eagles if you are dealing with a local authority.

Section 3(a)(iii): No Violation or Conflict

No, it doesn’t make any sense to add this agreement, nor to have a separate continuing warranty that you have not breached this agreement. That is tantamount to a no event of default rep — so you should already have it — and as canvassed in that very article, that representation is, in any case, a big old waste of time. If I tell you I have not breached the agreement, but in actual fact, I have, in what way are you in a better position than if I didn't tell you that?

Section 3(a)(iv): Consents

The “consents” representation attests that its giver has the necessary permissions regulatory status to carry out its obligations as contemplated under the contract: for example, that a broker-dealer carrying out a regulated activity, has the necessary authorisation and permission from any regulator claiming jurisdiction over the activity. A lack of regulatory authority is not likely to lead to outright voidability of the transaction — certainly not where that would run against the person whose interests a missing regulatory authorisation is meant to protect — and this sort of thing is usually covered in pre-contractual due diligence, so this is not a representation over which one spends a great deal of time agonising.

Here especially the caveat in the Misrepresentation Event of Default as to materiality might come in to play, if one has lost some trivial regulatory status, or perhaps one that increases the compliance cost of business that does not prevent the firm carrying out their business altogether.

Having successfully made this representation, your work is not over. Proceed to Section 4(b) where you covenant to maintain them, for better for worse, and in sickness and in health, and make reasonable efforts to obtain any new consents that might be needed in the future. Why the pedantic separation, you may ask? Because representations address the now and the past, and speak to states of affairs and not actions — any necessary action, ipso facto, having been already taken; whereas promises address the future where things are unknown, frightening and inherently fascinating for it is where, as Criswell correctly observed, you and I are going to spend the rest of our lives.

Section 3(a)(v): Obligations Binding

A representation that transgresses the very first rule of representations and warranties, which is that they are meant to be about matters of private, present fact, known to the representor but not the representee, but about which the representee cares a lot, and which might colour its decision to enter the contract in the first place.

Since the representee knows these things, the representor doesn’t, and they’re just facts, it can safely make representations about them to the representee to make it feel better.

But there are no such matters of private fact involved when one represents one’s obligations under a contract are binding: a contract is either valid and binding on a party or it isn’t; this isn’t the sort of thing that one party can conceal from the other. Indeed; whether a contract is valid and binding is not a question of fact at all: it’s a question of law.

It, therefore, requires an opinion, from one qualified to give such an opinion. The person who can attest to these is a special fellow. A boy wizard. A legal eagle. If you want to know whether your agreement is binding, don’t ask the counterparty; ask legal.

The obligations binding representation offends another principle of contractual representation, too: it is a pre-contractual statement as to a legal state of affairs which, by definition, has not yet come about. The “bindingness” of the contract is not a present fact at the time this representation is made. Representations as to the expected state of the world in the future are not generally called “representations”. They are called “promises”.

And yet there is more: if it is, somehow, a post-contractual representation,[18] albeit about a notionally current state of affairs,[19] it presents some kind of existential paradox or state of undecidability that not even Kurt Gödel can let us out of. For if this warranty is wrong, then the contract it lives in, QED, is invalid — that is to say, for all intents and purposes, does not exist, including this warranty. So precisely when you need to rely on it, you find it has vanished like some kind of that Schrödinger’s cat.

Subsection 3(b)

Comparison between versions

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 a misrepresentation that there has been no breach of that contract.

Discussion

Can you understand the rationale for this representation? Sure.

Does it do any practical good? No.

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.[20]

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, counselor.

“...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 Forest. 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[21] 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. Template:M detail 2002 ISDA 3(b)

Subsection 3(c)

Comparison between versions

Section 3(c) was one of the bits of the 1992 ISDA that ISDA’s crack drafting squadTM “got right” at the first time of asking. No changes in the 2002 ISDA, therefore.

Discussion

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

More generally, absence of litigation it is roundly pointless representation, but seeing as (other than unaffiliated Hedge Fund managers) no-one really complains about it, it is best to just leave well alone. It is one for the life’s too short file.

But if you do see your life stretching away unendingly to the horizon, and you haven’t got anything else in the calendar in the next half hour, go west, young man. Or woman.

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.[22] 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?

And 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[23]? Do we think it works? Do we? Given how[24] 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. Template:M detail 2002 ISDA 3(c)

Subsection 3(d)

Comparison between versions

ISDA’s crack drafting squadTM 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.

Discussion

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 flying starfish in the driest part of 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.

What’s that Section 3(d) representation malarkey?

If one is required to “furnishSpecified 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.

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 squadTM left this preposterous option open just in case. It wouldn’t be the first time.

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.

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

The importance of promptly furnishing[25] the documents for delivery goes as follows:

Subsection 3(e)

Comparison between versions

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?

Discussion

You’ll find the usual form of the Payer Tax Representations by clicking on that blue link. They livein Part 2 of the Schedule.

Withholding under the ISDA

TL;DR: The basic rationale is this:

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.

Template:M detail 2002 ISDA 3(e)

Subsection 3(f)

Comparison between versions

No change between the 1992 ISDA and the 2002 ISDA.

Discussion

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.

Template:M gen 2002 ISDA 3(f) Template:M detail 2002 ISDA 3(f)

Subsection 3(g)

Comparison between versions

If you are looking for a Section 3(a)(vi) in a 2002 ISDA, call off the police dogs: there is no such location. It is where one might have put a No Agency rep in a 1992 ISDA — but you modern types don’t need one of those. It’s already printed in a 2002 ISDA, at Section 3(g).

Discussion

If you like a bit of agency chat, you might like our articles about principals and agents, undisclosed agents, undisclosed principals and all that good stuff.

Investment managers as agents

In practice, many ISDA Master Agreements are entered by agentsinvestment managers and asset managers (so-called “real money” managers) — on behalf of underlying principalsinvestment funds, and institutional clients who have appointed them as discretionary investment advisers.

These managers often enter transactions in aggregate and only allocate them to their underlying principals later in the day. This means that the broker will have a nervous few hours before it knows whom it is expected to sue if the principal doesn’t pony up on time. General principles of agency — in particular liability for an undisclosed principal —mean agents are not quite so footloose and fancy-free as many of them seem to believe.

Look, it is not the end of the world if your counterpart refuses to renounce all agency, as long as you set up the accounts correctly with the underlying principals, and the firm has a robust approach to trade allocation. Ultimately — and notwithstanding the nervous few hours pending allocation — the person against whom you are, long term, booking the trade is the principal.

Internal agency model

It is not beyond the paranoid fantasies of a US tax attorney — a rich, baroque tapestry indeed — to want to “deem” a swap counterparty to be an agent for one of its affiliates for certain — you know, tax — purposes, even though the affiliate is not mentioned in the contract and the other side has not the first clue that this affiliate even exists.

How does this bear on your Section no agency representation? As far as your counterparty is concerned, not at all: a fellow acting under an agency he has not disclosed to his counterpart is called a “principal”. This is all the no agency representation is meant to confirm: for the avoidance of doubt — of which there wasn’t much anyway — you are not acting on behalf of someone else. Therefore, should you not perform our contract, I can bring my claim against you; you cannot slip out of the tackle by pointing to some under-capitalised espievie in a banana republic I didn’t know about whom you suddenly claim to be representing. I can therefore safely instruct my credit officer that the only commercial bona fides she needs to have in mind, as she slips on her rubber gloves, are yours.

It doesn’t matter whether the agency arrangement exists or not: either way, you are liable, as a principal, to me, it is your problem to recover any money you may be owed by your man in Havana.

Now whether such a representation undermines the fantastical aspirations of your tax attorney, on the other hand, is a question only he can answer. Template:M detail 2002 ISDA 3(g)

Section 4

Section 4 in a nutshell

4. Agreements

While either party has any obligation under this Agreement or any Credit Support Document:—
4(a) Furnish Specified Information. It will deliver to the other party (or to such government or taxing authority as it reasonably directs):—

(i) any tax documents specified in the Schedule or any Confirmation;
(ii) any other documents specified in the Schedule or any Confirmation; and
(iii) any other document the other party reasonably requests to minimise withholding tax on any payment (and which would not materially prejudice the provider’s position), if need be accurately completed and executed and delivered as specified in the Schedule or such Confirmation or, otherwise as soon as reasonably practicable.

4(b) Maintain Authorisations. It will use all reasonable efforts to maintain all regulatory consents and licences it needs to perform this Agreement or any Credit Support Document and will use all reasonable efforts to obtain any it may need in the future.
4(c) Comply With Laws. It will comply with all applicable laws if not doing so would materially impair its performance of this Agreement or any Credit Support Document.
4(d) Tax Agreement. It will tell the other party promptly after learning that any of its Section 3(f) representations have ceased to be accurate.
4(e) Payment of Stamp Tax. Unless incurred closing out a Transaction against a Defaulting Party (as to that, see Section 11), it will pay any Stamp Tax it incurs performing this Agreement by reason of it being in a Stamp Tax Jurisdiction, and will indemnify the other party against any such Stamp Tax that that party suffers, unless the jurisdiction in question also happens to be a Stamp Tax Jurisdiction for that other party.

Comparison between versions

4 Agreements

4(a) Furnish Specified Information
4(b) Maintain Authorisations
4(c) Comply with Laws
4(d) Tax Agreement
4(e) Payment of Stamp Tax

Discussion

A hodge-podge of “state the bleeding obvious” rules, breach of some of which justifies (eventual) close-out as a “breach of agreement” — flagrantly breaking the law, carelessly losing one’s regulatory authorisations — and random tax provisions and indemnities, which by and large don’t justify close-out.

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

The importance of promptly furnishing[26] the documents for delivery goes as follows:

Template:M detail 2002 ISDA 4

Subsection 4(a)

Comparison between versions

Section 4(a) of the 1992 ISDA is materially identical.

Discussion

Specified information” is not actually a defined term under the ISDA Master Agreement but merely a capitalised heading. In the JC’s book, capitalising a heading is borderline illiteracy, but ISDA’s crack drafting squadTM feels differently about it and we have learned which battles to pick. At any rate, the “Specified Information”, so called, is that stuff set out in the Schedule at Part 3. These are the documents that the parties agree to deliver to each other at certain times. Part 3 itemises what must be delivered, by whom, by when, and whether the Specified Information in question is covered by the Section 3(d) representation as to its accuracy and completeness. (What good would any information be that was not covered by that representation? We will let you amble over to the article on Section 3(d) to consider that.)

The Part 3 table will also totally bugger up the formatting in your document: it is a well-known fact that no ISDA negotiator on the face of the earth knows how to format a table in Microsoft Word.

Then again, nor does anyone else.

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

The importance of promptly furnishing[27] the documents for delivery goes as follows:

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 flying starfish in the driest part of 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.

What’s that Section 3(d) representation malarkey?

If one is required to “furnishSpecified 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.

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 squadTM left this preposterous option open just in case. It wouldn’t be the first time.

Withholding under the ISDA

TL;DR: The basic rationale is this:

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.

Template:M detail 2002 ISDA 4(a)

Subsection 4(b)

Comparison between versions

They’re the same. Exactly the same. They couldn’t even improve the punctuation, yo. Not even for the sake of it.

Discussion

The counterpart to the “Consents” representation of Section 3(a)(iv), only about the future, neatly illustrating the difference between a representation, being a declaration of fact about the state of the world in the present or past, and a covenant, being a solemn promise to do something about it in the future. Neither the past or the future is, as regards governmental consents is, tremendously controversial, so we do not propose to say anything more about it. Template:M gen 2002 ISDA 4(b) Template:M detail 2002 ISDA 4(b)

Subsection 4(c)

Comparison between versions

Section 4(c) represents another impeachable outing for the 1992 all-star line-up of ISDA’s crack drafting squadTM. Their successors, a decade down the line, couldn’t see any way to improve on their work. The two versions are thus the same.

Discussion

Hardly controversial that one must obey the law, but note this apparently inoffensive covenant converts that general public obligation into a private civil one, with definitive commercial consequences to your counterparty, hence the couching of the language in terms of materiality (twice) and specific ability to perform obligations under the ISDA Master Agreement. Template:M gen 2002 ISDA 4(c) Template:M detail 2002 ISDA 4(c)

Subsection 4(d)

Comparison between versions

Another immaculate outing from the ISDA’s crack drafting squadTM ’92 vintage. Exactly the same in both versions.

Discussion

These reps allow the other party to pay without deduction for certain taxes. This covenant puts the onus on the payee (beneficiary) to ensure the other party (who is subject to the authority of the taxing authority in question) is not erroneously passing through moneys that it should withhold and for which it will be personally liable to account to the tax authority. It also gives the aggrieved payer a direct right of action to claim those amounts back off the forgetful payee. Template:M gen 2002 ISDA 4(d) Template:M detail 2002 ISDA 4(d)

Subsection 4(e)

Comparison between versions

Other than a modicum of clerical tidy-up, the 1992 ISDA version of Section 4(e) is exactly the same as Section 4(e) in the 2002 ISDA version.

Discussion

Basically, if there is any Stamp Tax imposed because of my existence or residence in a certain jurisdiction, whether imposed on me or you, I’ll pay it, unless it would have been imposed on you too. If we’re both in the same Stamp Tax Jurisdiction, the liability lies where it falls. Template:M gen 2002 ISDA 4(e) Template:M detail 2002 ISDA 4(e)

Section 5

Section 5 in a nutshell

5. Events of Default and Termination Events

5(a) Events of Default

Any of the following events occurring to a party or its Credit Support Provider or Specified Entity will (subject to Sections 5(c) and 6(e)(iv)) be an “Event of Default”) for that such party:—

5(a)(i). Failure to Pay or Deliver. Failure by a party to make any payment or delivery when due under this Agreement which is not remedied by the first Local Business Day or Local Delivery Day after the party receives notice of the failure;
5(a)(ii)Breach of Agreement” means:
(1) a party breaches any of its obligations under the Agreement and doesn’t remedy the breach within 30 days of the other party’s notice other than the following:
(a) a Failure to Pay or Deliver;
(b) owning up to a Termination Event;
(c) not providing any necessary tax documents;
(d) any of its tax representations not being true; or
(2) a party repudiates this ISDA Master Agreement or any Transaction.
5(a)(iii) Credit Support Default.
(1) The party or its Credit Support Provider defaults under any Credit Support Document;
(2) Any Credit Support Document (or any security interest granted under one) terminates or becomes ineffective (except according to its terms) while any covered Transaction without the other party’s written consent; or
(3) the party or its Credit Support Provider repudiates any obligations under Credit Support Document;
5(a)(iv) Misrepresentation. A representation (other than a Payee or Payer Tax Representation) made under this Agreement or a Credit Support Document was materially incorrect or misleading when it was made;
5(a)(v) Default Under Specified Transaction. The party or any of its Credit Support Providers or Specified Entities:―
(1) defaults on any payment due under a Specified Transaction (or any related credit support arrangement) and as a result that Specified Transaction is validly accelerated (taking account of any grace periods);
(2) defaults on any final payment due under a Specified Transaction after taking account of any grace periods (or, if none, after one Local Business Day);
(3) defaults on any delivery due under a Specified Transaction (or any related credit support arrangement) and, all Transactions under the relevant Master Agreement are validly accelerated (taking account of any grace periods); or
(4) repudiates any Specified Transaction (or any related credit support arrangement);
5(a)(vi) Cross-Default. If “Cross-Default” applies to a party, it will be an Event of Default if:
(1) any agreements it (or its Credit Support Providers or Specified Entities) has for Specified Indebtedness become capable of acceleration; or
(2) it (or its Credit Support Providers or Specified Entities) defaults on any payment of Specified Indebtedness (and any grace period expires);
And the total of the principal amounts in (1) and (2) exceeds the Threshold Amount.
5(a)(vii). Bankruptcy. A party of its Credit Support Provider or Specified Entity:―
(1) Dissolved: is dissolved (other than by merger);
(2) Insolvent: becomes insolvent, unable to pay its debts, or admits it in writing;
(3) Composition with Creditors: makes a composition its creditors;
(4) Insolvency Proceedings: suffers insolvency proceedings instituted by:
(A) a regulator; or
(B) anyone other than a regulator, and
(I) it results in a winding up order; or
(II) those proceedings are not discharged within 15 days;
(5) Voluntary Winding Up: resolves to wind itself up (other than by merger);
(6) Put in Administration: has an administrator, provisional liquidator, or similar appointed for it or for substantially all its assets;
(7) Security Exercised: has a secured party take possession of, or a legal process is enforced against, substantially all its assets for at 15 days without a court dismissing it;
(8) Analogous events: suffers any event which, under the laws of any jurisdiction, has the same effect as any of the above events; or
(9) Action in furtherance: takes any action towards any of the above events.
5(a)(viii) Merger Without Assumption. The party (or a Credit Support Provider) merges with or transfers or all or substantially all its assets to another entity and:―
(1) the resulting entity does not assume all the original party’s obligations under this Agreement (or Credit Support Document); or
(2) the Credit Support Document does cover the resulting party’s obligations under this Agreement.

5(b) Termination Events

The events below occur to a party or its Credit Support Provider or Specified Entity (subject to Section 5(c)) it will be an Illegality (5(b)(i)); a Force Majeure Event (5(b)(ii)), a Tax Event (5(b)(iii)), a Tax Event Upon Merger (5(b)(iv)) and Credit Event Upon Merger (5(b)(v)):

5(b)(i) Illegality. Taking account of any fallbacks and remedies in the Transaction, for reasons beyond the Affected Party’s control, (not counting a lack of authorisation required under Section 4(b)), it would be illegal in any relevant jurisdiction to comply with any material term of a Transaction or Credit Support Document.
5(b)(ii) Force Majeure Event. A force majeure occurring after any Transaction is executed means:―
(1) the Affected Party’s relevant Office cannot practicably perform any obligation under the Transaction; or
(2) the Affected Party or its Credit Support Provider cannot practicably perform any obligation under the Transaction;
if the force majeure is outside the Affected Party’s control and it could not, using all reasonable efforts (without incurring more than incidental expenses by way of loss), overcome the necessary prevention;
5(b)(iii) Tax Event It will be a Termination Event when, following a change in tax law or practice after any trade date, an Affected Party is likely to have to either:
(1) Gross up an Indemnifiable Tax deduction (other than for interest under Section 9(h)); or
(2) receive a payment net of Tax which the Non-Affected Party is not required to gross up (other than where it is caused by the Non-Affected Party’s own omission or breach).
5(b)(iv) Tax Event Upon Merger. A party (the “Burdened Party”) on the next Scheduled Settlement Date will have to:
(1) Gross up an Indemnifiable Tax deduction (other than for interest under Section 9(h)); or
(2) receive payments net of Tax which are not required to be grossed up (other than where that is caused by the Non-Affected Party’s own omission or breach);
because a party has merged with, transferred substantially all of its assets into, or reorganised itself as, another entity (the Affected Party) where that does not amount to a Merger Without Assumption;
5(b)(v) Credit Event Upon Merger. If “Credit Event Upon Merger” applies and it or any of its Credit Support Providers or Specified Entities suffers a Designated Event (which is not a Merger Without Assumption) and the relevant entity’s (which will be the Affected Party) creditworthiness is materially weaker as a result.
A “Designated Event” means that the relevant entity:―
(1) merges with, or transfers substantially all of its assets into, or reorganises itself as another entity;
(2) comes under the effective voting control of another entity; or
(3) makes a substantial change in its capital structure by issuing or guaranteeing debt, equities or analogous interests, or securities convertible into them;
5(b)(vi) Additional Termination Event. If any “Additional Termination Event” is specified, the occurrence of that event (where the Affected Party will be as specified in the Confirmation or Schedule).

5(c) Hierarchy of Events.

5(c)(i) As long as an event counts as an Illegality or a Force Majeure Event, it will not count as an Failure to Pay or Deliver, a non-repudiatory Breach of Agreement or the first limb of Credit Support Default.
5(c)(ii) In any other circumstances, an Illegality or a Force Majeure Event which also counts as an Event of Default or a Termination Event, will count as the relevant Event of Default or Termination Event, and not the Illegality or Force Majeure Event.
5(c)(iii) If a Force Majeure Event also counts as an Illegality, it will be treated as an Illegality and not a Force Majeure Event (unless covered by clause 5(c)(ii) above).

5(d) Deferral of Payments and Deliveries During Waiting Period. If an Illegality or a Force Majeure Event exists for a Transaction, payment and delivery obligations under that Transaction will be deferred until:―

5(d)(i) the first Local Business Day (or, for deliveries, the first Local Delivery Day) following the end of the Waiting Period for event in question; or, if earlier:
5(d)(ii) the first Local Business Day or Local Delivery Day on which the Illegality or Force Majeure Event does not exist.

Comparison between versions

5 Events of Default and Termination Events

5(a) Events of Default

5(a)(i) Failure to Pay or Deliver
5(a)(ii) Breach of Agreement
5(a)(iii) Credit Support Default
5(a)(iv) Misrepresentation
5(a)(v) Default Under Specified Transaction
5(a)(vi) Cross Default
5(a)(vii) Bankruptcy
5(a)(viii) Merger without Assumption

5(b) Termination Events

5(b)(i) Illegality
5(b)(ii) Force Majeure Event
5(b)(iii) Tax Event
5(b)(iv) Tax Event Upon Merger
5(b)(v) Credit Event Upon Merger
5(b)(vi) Additional Termination Event

5(c) Hierarchy of Events
5(d) Deferral of Payments and Deliveries During Waiting Period
5(e) Inability of Head or Home Office to Perform Obligations of Branch

Discussion

Events of Default vs. Termination Events: Showdown

Puzzled ISDA ingénues[28] may wonder why there are Events of Default and Termination Events under the, er, eye-ess-dee-aye. In any weather, there seem to be rather a lot of them. And there is a third, hidden category: Additional Termination Events that the parties crowbar into the Schedule.

Do we really need all these[29], and what is the difference?

So, with feeling:

Events of Default...

Termination Events ...

Template:M gen 2002 ISDA 5 Template:M detail 2002 ISDA 5

Subsection 5(a)

Comparison between versions

5(a) Events of Default

5(a)(i) Failure to Pay or Deliver
5(a)(ii) Breach of Agreement
5(a)(iii) Credit Support Default
5(a)(iv) Misrepresentation
5(a)(v) Default Under Specified Transaction
5(a)(vi) Cross Default
5(a)(vii) Bankruptcy
5(a)(viii) Merger without Assumption

Discussion

Types of Events of Default

Independently verifiable

Some Events of Default you can independently verify without counterparty's confirmation, for example:

Not independently verifiable

Some require the counterparty to tell you as they depend on facts which you could not know are not public knowledge, are not breaches of a direct obligation to the counterparty and would not otherwise come to the firm's attention: Particularly:

  • Cross Default
  • other limbs of Bankruptcy (eg "has a secured party take possession of all or substantially all its assets".
“Hard” Events of Default

Hard events where some positive action has actually been taken representing a default - such as a Failure to Pay

“Soft” or “Passive” Events of Default

Where a state of affairs has arisen permitting a hard Event of Default to be called, but it has not been designated it happened, such as Cross Default, where person owning the actual "hard" default right against your counterparty may not have triggered (or have any intention of triggering) it.

That said, and for the same reason, such “not independently verifiable” termination/default events are effectively soft anyway, even where we have such an obligation from counterparty to notify us of their occurrence, because we have no means of policing whether or not the Counterparty has in fact notified us, and therefore no practical remedy anyway if it does not. It is a self certification, after all, and all we can rely on is its moral force and the party's competence to monitor its own position and be sufficiently organised to tell us.

Additionally, the obligation on a counterparty to monitor "passive" Events of Default like Cross Default (as opposed to cross acceleration where QED a defaulting party will be notified about the occurrence) is a pretty onerous one particularly for a large entity, and even more so where (as they often are for funds) derivatives are included in definition of Specified Indebtedness.

Given that cross defaults may have artificially low Threshold Amounts (as do some of ours) and are set at levels where actual counterparties owning those rights directly are most unlikely to exercise them, it should not be a surprise to find parties resistant to notifying us about these.

This becomes a credit call but a practical recommendation would be:

  1. Impose notification requirement only on "active" termination/default events which are non-public and CP has no excuse for not having monitored them and counterparty has actually exercised; and
  2. If that doesn't work, agree to drop the provision altogether, as in my view its practical utility is limited to "moral" at best (as there is no effective sanction for counterparty breach anyway)

Illegality

Illegality trumps Event of Default. Be careful where, for example, a Failure to Pay is occasioned by a mandatory change in law by a government having jurisdiction over one or other counterparty — see Illegality. Good example: Greek capital controls of June 2015.

Events of Default vs. Termination Events: Showdown

Puzzled ISDA ingénues[34] may wonder why there are Events of Default and Termination Events under the, er, eye-ess-dee-aye. In any weather, there seem to be rather a lot of them. And there is a third, hidden category: Additional Termination Events that the parties crowbar into the Schedule.

Do we really need all these[35], and what is the difference?

So, with feeling:

Events of Default...

Termination Events ...

Template:M detail 2002 ISDA 5(a)

Subsection 5(a)(i)

Comparison between versions

The significant change between 1992 ISDA and 2002 ISDA is the restriction of that grace period from three Local Business Days to one. And a bit of convolutional frippery in introducing Local Delivery Days as well.

Discussion

Failure to Pay under Section 5(a)(i) of the ISDA Master Agreement: where a party fails to pay or deliver on time and does not remedy before the grace period expires. The grace period for a 2002 ISDA is one Local Business Day; shorter than the three Local Business Days in the 1992 ISDA. This fact alone has kept a number of market counterparties on the 1992 form, nearly thirty years after it was upgraded. There is an inverse relationship between the amount of time you will spend negotiating a point in an ISDA Master Agreement and the practical difference it will make once your ISDA Master Agreement has been inked and stuffed in a filing cabinet in a cleaning cupboard behind the lavatories electronically stored, data-enriched, in a comprehensive online legal data repositary.

Closing out an ISDA Master Agreement following an Event of Default

Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.

In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.

So, you will need:

(i) a Failure by the Defaulting Party to make a payment or delivery when due;
(ii) a notice by the Non-Defaulting Party under Section 6(a) to the Defaulting Party that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.
(i) The standard grace periods are set out in Section 5(a)(i). Be careful here: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
(ii) So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
(iii) At the expiry of this grace period, you finally have a fully operational Event of Default. Now Section 6(a) gives you the right, by not more than 20 days’ notice[41] to designate an Early Termination Date for all outstanding Transactions. So, at some point in the next twenty days.
(iv) For this we go to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked. For it not to be (i.e., if Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.

Template:M detail 2002 ISDA 5(a)(i)

Subsection 5(a)(ii)

Comparison between versions

Note the addition of Repudiation of Agreement to the 2002 ISDA. Common law purists like the JC will grumble that you don’t really need to set out repudiation as a breach justifying termination of a contract, because that’s what it is by definition but stating the bleeding obvious has never stopped ISDA’s crack drafting squadTM before.

Discussion

A failure to perform any agreement, if not cured within 30 days, is an Event of Default, except for:

(i) those failures which already have their own special Event of Default (i.e., Failure to Pay or Deliver under Section 5(a)(i)) or
(ii) those that relate to tax, and which mean the party not complying will just get clipped for tax it rather would not.

These are the boring breaches of agreement: those of a not immediately existential consequence to a derivative relationship (like Failure to Pay or Deliver, or a party’s outright Bankruptcy) but which, if not promptly sorted out, justify shutting things down with extreme prejudice.

All rendered in ISDA’s crack drafting squadTM’s lovingly tortured prose, of course: note a double negative extragvaganza in 5(a)(ii)(1): not complying with an obligation that is not (inter alia) a payment obligation if not remedied within a month. High five, team ISDA.

Hierarchy of Events

Note that a normal Section 5(a)(ii)(1) Breach of Agreement that also comprises a Section 5(b)(i) Illegality or a Section 5(b)(ii) Force Majeure Termination Event will, courtesy of section 5(c), be treated as the latter, but a repudiatory Breach of Agreement under section 5(a)(ii)(2) willl not enjoy the same leniency. If you have repudiated your contract, the fact that there happens to be a concurrent Illegality — it is hard to see how a repudiatory breach could be an Illegality in itself — will not save you from the full enormity of section 5(a)(ii) Event of Default style close out.

Failure to Pay or Deliver carve-out

Why is Section 5(a)(i) specifically carved out? No good reason, other than ISDA’s crack drafting squadTM’s general neurosis/delight in over-communicating. Yes, it has its own separate Event of Default, with a much tighter timeline, so in practice one would never realistically trigger a failure to pay as a 5(a)(ii) event, but it is still a bit fussy carving it out.

ISDA’s crack drafting squadTM. Never knowingly outfussed.TM

It is an Event of Default not to supply documents for delivery

A failure to Furnish Specified Information — ie those documents for delivery specified in Part 3 of the ISDA Master Agreement, adverted to in Section 4(a)(ii) will therefore be an Event of Default, although you have to navigate a needlessly tortured string of clause cross references and double negatives to settle upon this conclusion. Template:M detail 2002 ISDA 5(a)(ii)

Subsection 5(a)(iii)

Comparison between versions

A bit of pedantic flannel found its way into the 2002 ISDA — it captures not just the failure of the Credit Support Document itself, but any security interest granted under it, catering to the legal eagle’s most paranoid fears that a contractual right can have some sort of distinct ontological existence independently from the agreement which gives it breath and enforceable currency in the first place. But otherwise the same.

Discussion

Note the charming contingency that ISDA’s crack drafting squadTM allows that a counterparty might default under a credit assurance offered by someone else altogether.

Before you even put your hand up: no, a Credit Support Annex between the two counterparties is not a Credit Support Document, at least under the English law construct: there it is a “Transaction” under the ISDA Master Agreement. It is somewhat different with a 1994 ISDA CSA (NY law), but even there the User Guide cautions against treating a direct swaap counterparty as a “Credit Support Provider” — the Credit Support Provider is meant to be a third party. For paranoia junkies and conspiracy theorists amongst you, note the long reach this event of default gives to a Cross Default provision. Now, granted, in the ordinary course Cross Default keys off borrowed money or indebtedness, and by common convention that does not count out-of-the-money exposures under derivative contracts, so the ISDA Master Agreement’s own events of default should not exacerbate your cross-default risk under other contracts. Unless you widen Specified Indebtedness to include derivative exposures, as some counterparties do.

Okay; buckle in, for this is a bit of a Zodiac Mindwarp. But if you widen your conception of Specified Indebtedness ...

Now we see that courtesy of Section 5(a)(iii), a default by my Credit Support Provider (which, remember, need not be my parent: it may be an unaffiliated third-party like a bank writing a letter of credit or financial guarantee) is also default under my ISDA Master Agreement, even where I personally am fully solvent, in good standing, of sound credit and up-to-date with my rent, outgoings, credit card payments and so on.

Fair enough, you might say, for that Credit Support Document was a fundamental part of your calculus when you agreed to trade swaps with me in the first place, and so it was — but, since (through 5(a)(iii) that guarantor’s default counts as my default under our ISDA Master Agreement, through a carelessly widened cross-default in another facility that same guarantor default could be used by my other counterparties to accelerate those other facilities, even though those other facilities are not guaranteed by the same guarantor. So there is this ugly — rather theoretical, I grant you, but nonetheless ugly — snowball risk.

Just something to think about when your own credit department tries to loosen the waistband of what kinds of obligations trigger Cross Default, anyway. Template:M detail 2002 ISDA 5(a)(iii)

Subsection 5(a)(iv)

Comparison between versions

No change between 1992 ISDA and 2002 ISDA. Nothing to see here, folks. Move along please.

Discussion

The purist’s objection is that, since a representation is a pre-contractual statement which induced the wronged party to enter the contract and (ergo) was not, and could not be, itself, a contractual term at all — its bolt was shot before minds met, so to speak — and as such, one’s remedy for misrepresentation ought to be to set aside the contract altogetherab initio, as Latin lovers would say — voiding it on grounds of lack of consensus, and not suing for damages for breach of something which, by your own argument, never made it into the cold hard light of legal reality. The JC is nothing if not a purist. We feel that, as written, this provision is a mite misconceived.

Giving our friends at ISDA the benefit of the doubt we think ISDA’s crack drafting squadTM means “breach of warranty”, and were really just being loose with terminology. There again, unlike other, more fundamental obligations, misrepresentation as an Event of Default has neither a materiality threshold or the accomodation to the wrongdoer in the form of a grace period or even a warning notice, so perhaps not. Anyway.

This is where that mystifying Section 3(d) representation comes in.
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 flying starfish in the driest part of 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.

What’s that Section 3(d) representation malarkey?

If one is required to “furnishSpecified 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.

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 squadTM left this preposterous option open just in case. It wouldn’t be the first time.

How material is “material”?

What is a “material” respect? This is key, since some of the general representations (Consents, for example) are quite wide, and in this world of regulatory perma-change, the risk that one is, for example, outside technical compliance with a new regulation as it is implemented, notwithstanding a competent regulator’s informal indication that no action will be taken if you get your skates on and remediate quickly — it happened for MiFID II as thousands of financial firms raced headlong at the brick wall of that 3 January 2017 implementation date[45] but it seems reasonable to suppose that materially must somehow impact your ability to carry out your obligations under a Transaction or the ISDA Master Agreement[46].

Representations by agents on agent’s own behalf

Where your client’s obligations under the ISDA Master Agreement are stewarded by an agent — quite common for an investment manager trading on behalf of a fund — a broker might think about having the agent represent, on its own behalf, about its role as agent. It might ask the agent to do this in the ISDA. The sound of an asset manager confirming its ongoing authority to bind its principal gladdens a broker’s heart. A full-throated assertion of its own regulatory authorisation; its continued good standing with the companies office; the continued involvement of its key persons in making investment decisions — each is sure to put a jaunt in a broker’s stride. Imaginative in-house counsel for the broker will doubtless dream up others.

But tarry a while. Firstly, your investment manager will sign as agent, for the client, not on its own behalf. For many this will be an article of profound faith: they will be at some pains, which they will willingly inflict on you, to avoid the barest hint they are speaking for themselves. “When an agent, as agent opens its mouth,” they will tell you, “it becomes its principal for all purposes that interest the law.”

And so it does. As far as the Courts of Chancery are concerned, to be an agent is to be wholly transubstantiated into the person of one’s principal. Transmogrified. It is, for all forensic intents to disappear; one’s ghostly outline may still be there, but it is a chimera: one exists only to be the earthly representation of another.

Which cast a pall over the representations you are being asked to make.

Take the one that “the principal has duly authorised the agent to act on its behalf”. For the principal to say that, through the person of the very one whose agency is in question, is some kind of Möbius loop. The very comfort you might draw from what is being said is taken away by the person who is saying it.

Even if the fact of the agency is in no doubt, the statements as to the agent’s character may be problematic. The agent is speaking for the principal, remember.

The exchange might go something like this:

Agent (as agent): Why would I be authorised by the FCA? I am not advising anyone. In fact, my investment manager is advising me. Why don’t you ask her?
Broker (rubbing its eyes and peering at the agent): But I am asking her. I mean you.
Agent (as agent): Who?
Broker: You! The investment manager for this blessed fund!
Agent (as agent): Ah, but I am not me, for now, you see. I am the earthly representative of the fund. In my own personal capacity, I don’t exist.
Broker: But you are here, aren’t you? Can’t I just quickly ask you? Can’t you just, you know, be yourself for a moment? It won’t take a mo —
Agent (as itself): What? Here? In this ISDA? You must be joking. I told you under no circumstances will I act as principal.
Broker (A light-bulb comes on): Aha! I've got it! All right then: can you make representations on behalf of your principal?
Agent (as agent) (Thinks for a moment.): Why yes! Yes, I can! That’s what I’m here, as agent, to do! What would you like me to represent?
Broker: Could you represent that your investment manager is duly authorised by the FCA?
Agent (as agent): WELL HOW THE HELL AM I SUPPOSED TO KNOW THAT??
Broker: What?
Agent (as agent): Look: why don’t you ask the agent?

But seriously

Assuming you can persuade your agent to represent, on its own behalf, about itself, as to these matters (whether in the master agreement itself or in a side letter):

  • Now if (notwithstanding breach of this rep) the broker does still have a claim against the fund, then no harm no foul: we shouldn’t need to close out vs the fund unless/until there’s an independent failure to pay, in which case rely on that. But now we have actual knowledge of the agent’s lack of authority we may find we have a second problem: that there is no no-one with ostensible authority to bind the fund, and it is drifting rudderless towards a wall. If so, see below.
  • If we don’t then our action is necessarily against the agent in its personal capacity and against its own assets, not the fund’s. It’s a claim in tort for negligent misstatement. Put yourself in the fund’s position here. Being itself a victim of the agent’s mendacity it will feel it is more sinn’d against than sinning and will not see why this should be a 3(d) representation under the ISDA Master Agreement. The fund will say “well hang on: I didn’t do anything wrong here: this asset manager is taking my name in vain without my consent – so how is it that you’re purporting to close out against me?
  • Loss of manager’s regulatory status, no manager, no good standing etc: The other typical representations goes to a duly authorised manager’s continued ability to to act on the fund’s behalf: to manage positions, monitor risk tolerances and keep the ship steady. If the agent goes AWOL a [[[broker]] has some call to reduce risk against the fund. If the fund is a sports car, the broker’s ATEs are the measures it can take to prevent the car hitting a wall. As long as here is a competent agent driving the car, the broker can have some confidence the car will avoid walls by itself. If the driver is prevented from steering, the car will, eventually, hit the wall. So it is fair enough for the broker to say “okay: you are out of control: unless you name a new driver, within a given period ~ and here you may treat yourself to a fun exchange with your counterpart about how long that period should be ~ we can call this an ATE”.

Template:M detail 2002 ISDA 5(a)(iv)

Subsection 5(a)(v)

Comparison between versions

Template:M comp disc 2002 ISDA 5(a)(v)

Discussion

Default Under Specified Transaction — colloquially, “DUST” — is often confused with Cross Default. In fact, they’re meant to be mutually exclusive. That won’t stop folks conflating them, though. Look, we all do it.

DUST is like Cross Default, but where Cross Default references indebtedness owed to third parties, DUST is all about non-“borrowing” style transactions — e.g., swap agreements, stock loans[48] and repos, but only transactions between the two counterparties[49].

If a Counterparty[50] experiences an Event of Default under a swap agreement (or other “Specified Transaction[51] with you, this will be an Event of Default under the ISDA Master Agreement.

Acceleration, not Default

DUST is triggered by an acceleration following an event of default under the Specified Transaction, not upon the default itself[52]. Since the Specified Transaction is between you and the other party to the ISDA Master Agreement, there is no great loss — it is within your gift to accelerate the other contract — and to achieve set-off you would have to do so anyway.

This is less drastic than the corresponding Cross Default provision, which imports all the Events of Default from all Specified Indebtedness into the present one[53], even if the counterparty to the defaulted contract has itself waived its rights to exercise.

Final payments

The reason for the second limb of the definition is to catch final payments, which can’t be accelerated, since they’re already due.

Differences between cross default and DUST

Ideally, cross default and DUST should be mutually exclusive. They are meant to dovetail with each other, not cross over. This will not stop mission creep from over-zealous credit departments, who will try to expand the scope of each, leading to all kinds of cognitive dissonances and righteous[54] indignation from the counterparty’s negotiator. As ammunition for your fruitless attempts to persuade the credit department to live in the real world for once, try these:

  • Cross default generally references indebtedness where the exercising counterparty has significant loan-type exposure to the defaulter; DUST references bilateral derivative and trading transactions which tend not to be in the nature of indebtedness (it is true to say that the line between these can be gray, especially in the case of uncollateralised derivative relationships;
  • Cross default is only triggered once a certain threshold amount of indebtedness is defaulted upon; DUST is triggered upon any breach;
  • Cross default references your Counterparty owes to a third party outside your control; DUST references other obligations your counterparty owes you or an affiliate you can reasonably be expected to be in league with. (ie you can't generally trigger if your counterparty defaults on Specified Transactions it has on with third parties)
  • DUST only comes about if the Specified Transaction in question has been actually accelerated, whereas cross default is available whether the primary creditor has accelerated or not. (A cross default which requires acceleration is called “cross acceleration”.)

Payment acceleration versus delivery acceleration — mini close-out

Upon a payment default under 5(a)(v)(1), only that particular transaction must be accelerated (it doesn’t require full close out of the relevant Master Agreement. But a delivery default under 5(a)(v)(3), is only triggered if the whole Master Agreement is closed out.

Why would that be? Oh! Yes, Stock loan ninja at the back, with your hand up!

Stock loan ninja (for it is he): Sir! Sir! Please sir, is this to stop the mini-closeout of a single Loan under a 2010 GMSLA?
The JC (beaming inscrutably): Yeeeees — Go on — ?
SLN: Sir, please sir, settlement failures under a stock loan are often a function of market illiquidity (the asset to be delivered isn’t available) and aren’t necessarily indicative of credit deterioration, sir, so should not necessarily trigger a DUST under the ISDA. But this situation would never apply to a simple cash payment. On the other hand, if the whole 2010 GMSLA is closed out as a result of a delivery fail, you clearly are in a credit-stress situation.
JC: Excellent!

What if I “jump the gun”?

Could a wrongfully submitted notice of default be treated as a repudiation/anticipatory breach by the “non-defaulting party” giving the other party at least the right to withhold payments on the basis that this would constitute a Potential Event of Default by the party submitting the notice? There’s not much law on point, but the starting point is “no” - it would simply be an ineffective notice. However, a non-payment on the basis of an ineffective notice would be impermissible and may itself amount to a Failure to Pay. But as to the mere dispatch of the notice itself, there is relatively recent case law[55] (albeit in the bond world) stating that an acceleration notice that is submitted wrongfully, i.e. when no actual event of default, is merely ineffective and does not give rise to a claim for breach of contract or damages from “defaulting party”. Clearly this has not been considered in context of ISDA per se (and may be nuances here that would lead to different result) but at it is a start.

Subsection 5(a)(vi)

Comparison between versions

This article is specifically about the Cross Default provision in the ISDA Master Agreement. For a general discussion of the concept, see cross default.

The 2002 ISDA updates the 1992 ISDA’s Cross Default so that if the combined amount outstanding under the two limbs of Cross Default exceed the Threshold Amount, then it will be an Event of Default. Normally, under the 1992 ISDA, Cross Default requires one or the other limbs to be satisfied — you can’t add them together. This was a bit of a snafu. The two limbs are:

Discussion

General

Cross Default is intended to cover off the unique risks associated with lending money to counterparties who have also borrowed heavily from other people. If you try to apply it to contractual relationships which aren't debtor/creditor in nature — as starry-eyed young credit officers in the thrall of the moment like to — it will give cause trouble. This will not stop credit officers doing that. Note also that it is, as are most ISDA provisions, bilateral. If you are a regulated financial institution, the boon of having a Cross Default right against your counterparty may be a lot smaller than the bane of having given away a Cross Default right against yourself.

Under the ISDA Master Agreement, default by a swap counterparty for “Specified Indebtedness” with a third party in an amount above the “Threshold Amount” is an Event of Default under the ISDA Master Agreement. Cross Default thus imports all the default rights from the Specified Indebtedness in question into your ISDA Master Agreement. For example, if you breach a financial covenant in your revolving credit facility with some other bank, an entirely different swap counterparty could close you out even if your bank lender didn’t.

Cross Default is, therefore, theoretically at least, a very dangerous provision. Financial reporting dudes get quite worked up about it. Yet, it is very rarely triggered[56]: It is inherently nebulous. credit officers disdain nebulosity and, rightly, will always prefer to act on a clean Failure to Pay or a Bankruptcy. Generally, if you have a daily-margined ISDA Master Agreement, one of those will be along soon enough.

“Okay, so why do we even have a Cross Default in an ISDA Master Agreement?” I hear you ask. Great question. Go ask ISDA’s crack drafting squadTM. The best we can figure is when they put it into the document, back in the 1980s, swaps were new, they hadn't really thought them through, no-one realised how they would explode[57] and in any case folks back then held lots of opinions we would now regard as quaint. I mean, just look at the music they listened to.

Specified Indebtedness

Specified Indebtedness is generally any money borrowed from any third party (e.g. bank debt; deposits, loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation.

Threshold Amount

The Threshold Amount is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — schoolboy error hazard alert — be careful to say whether it is the greater or lesser of the two. It should be big: like, life-threateningly big - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or (for banks) sums in the order of hundreds of millions of dollars. For funds it could be a lot lower — like, ten million dollars — and, of course, will reflect NAV not shareholder funds.

Specified Indebtedness

Specified Indebtedness is a simple and innocuous enough provision. Almost redundant, you’d think — why go to the trouble of defining “borrowed money” as another term? (Answer: because many firms, in their wisdom, will wish to change the definition in the Schedule to include derivatives, other trading exposures, things owed to their affiliates, or even any payment obligations of any kind, and for those people, “Specified Indebtedness” is a (somewhat) less loaded term.[58]

In any case, what should one make of “borrowed money”? Could it include repo and stock loan obligations under securities financing transactions? Amounts owed to trade creditors? (In each case no, according to Simon Firth - see here).

Initial margin: a trick for young players

What of a failure to pay an Independent Amount? Technically this is not a payment of indebtedness, and if the IM payer is up-to-date on variation margin payments, there may not be any indebtedness at all. Indeed, once the IM payer has paid required IM, the IM receiver becomes indebted to the payer for the return of the initial margin — so while it certainly comprises a failure to pay when due, the value of the Specified Indebtedness that failure contributes to the Threshold Amount might be nil, or even negative. This, your risk people will say, is why one should widen Specified Indebtedness to include all payment obligations, but that, for a host of reasons you can find here — is whopping great canard a l’orange in this old contrarian’s opinion.

Cross acceleration

You can quickly convert a dangerous Cross Default clause into a less nocuous (but still fairly nocuous, but yet strangely pointless) cross acceleration — a right that is only available where the lender in question has actually accelerated its Specified Indebtedness, not just become able to accelerate it.

Want to quickly convert Cross Default to Cross Acceleration? Click here.

Measure of the Threshold Amount

  • 1992 ISDA: This contemplates default “in an aggregate amount” exceeding the Threshold Amount which would justify early termination of the Specified Indebtedness: that is to say the value of the failed payment, and not the whole principal amount of the Specified Indebtedness it was owed under, contributes to the Threshold Amount, ;
  • 2002 ISDA: This contemplates an event of default under agreements whose “aggregate principal amount” is greater than the Threshold Amount: that is to say it is the whole principal amount of the agreement which is picked up, not just the amount of the payment.

This change, we speculate, is meant to fix a howler of a drafting lapse from ISDA’s crack drafting squadTM:

  • It can be triggered by any event of default, not just a payment default (i.e. the 1992 ISDA requirement for “an Event of Default ... in an amount equal to...” impliedly limits the clause to payment defaults only since other defaults aren't “in an amount”...);
  • It captures the whole value of the Specified Indebtedness, not just the value of the default (if it even is a payment capable of being valued) itself.

For example: if you defaulted on a small interest payment on your Specified Indebtedness which made your whole loan repayable, under the 1992 ISDA you could only count the value of that missed interest payment to your Threshold Amount. But the whole loan is at risk of being accelerated — so this is a much more significant credit deterioration than is implied by the missed payment.

It is innocuous, that is, unless you are cavalier enough to include derivatives or other payments which are not debt-like in your Specified Indebtedness. But if you do that, you've bought yourself a wild old ride anyway.

Don't say you weren't warned.

Differences between cross default and DUST

Ideally, cross default and DUST should be mutually exclusive. They are meant to dovetail with each other, not cross over. This will not stop mission creep from over-zealous credit departments, who will try to expand the scope of each, leading to all kinds of cognitive dissonances and righteous[59] indignation from the counterparty’s negotiator. As ammunition for your fruitless attempts to persuade the credit department to live in the real world for once, try these:

  • Cross default generally references indebtedness where the exercising counterparty has significant loan-type exposure to the defaulter; DUST references bilateral derivative and trading transactions which tend not to be in the nature of indebtedness (it is true to say that the line between these can be gray, especially in the case of uncollateralised derivative relationships;
  • Cross default is only triggered once a certain threshold amount of indebtedness is defaulted upon; DUST is triggered upon any breach;
  • Cross default references your Counterparty owes to a third party outside your control; DUST references other obligations your counterparty owes you or an affiliate you can reasonably be expected to be in league with. (ie you can't generally trigger if your counterparty defaults on Specified Transactions it has on with third parties)
  • DUST only comes about if the Specified Transaction in question has been actually accelerated, whereas cross default is available whether the primary creditor has accelerated or not. (A cross default which requires acceleration is called “cross acceleration”.)

Subsection 5(a)(vii)

Comparison between versions

Differences between 1992 ISDA and 2002 ISDA definitions of Bankruptcy

There are two:

  • Slightly more specific concept of insolvency: firstly, in limb 4 (insolvency proceedings) a new limb (A) has been included to cover action taken by an entity-specific regulator or supervisor (as opposed to a common or garden insolvency proceeding): If initiated by a regulator, the game’s up as soon as the action is taken. If initiated by a random, the action must have resulted in a winding-up order, or at least not have been discharged in 15 (not 30) days.
  • Contracted grace period: The allowable period for dismissal of an insolvency petition (under 5(a)(vii)(4)) or the exercise of security over assets (under 5(a)(vii)(7)) is compressed from 30 days to 15 days. This, in aggregate over the whole global market, keeps many a negotiator in meaningful[60] employment, and you will see many large organisations, whom you’d think would know better, amending these grace periods back to the 1992 ISDA standard of 30 days or better still, insisting on sticking with a 1992 ISDA, but upgrading every part of it to the 2002 ISDA except for the Bankruptcy and Failure to Pay grace periods. This is a simply spectacular use of ostensibly limited resources.

Regional bankruptcy variations

The Germanic lands have peculiar ideas when it comes to bankruptcy — particularly as regards banks, so expect to see odd augmentations and tweaks to ISDA’s crack drafting squadTM standard language. Will these make any practical difference? Almost certainly not: it is hard to see any competent authority in Germany, Switzerland or Austria — storeyed nations all, in the long history of banking, after all — not understanding how to resolve a bank without blowing up its netting portfolio. Especially since Basel, where the netting regulations were formulated, is actually in Switzerland.

1987 ISDA

Note, for students of history, Automatic Early Termination is problematic under the 1987 ISDA.

Discussion

ISDA’s is the market standard way of defining “bankruptcy

The ISDA bankruptcy definition is rarely a source of great controversy (except for the grace period, which gets negotiated only through custom amongst ISDA negotiators because, in its wisdom, ISDA’s crack drafting squadTM thought fit to halve it from 30 days to 15 in the 2002 ISDA.

So you have a sort of pas-de-deux between negotiators where they argue about it for a while before getting tired, being shouted at by their business people, and moving on to something more important to argue about, like Cross Default).[61]

Otherwise, the ISDA bankruptcy clause is a much loved and well-used market standard and you often see it being op-opted into other trading agreements precisely because everyone knows it and no one really argues about it. Template:M gen 2002 ISDA 5(a)(vii) Template:M detail 2002 ISDA 5(a)(vii)

Subsection 5(a)(viii)

Comparison between versions

As the comparison illustrates (see panel below right), ISDA’s crack drafting squadTM giveth and ISDA’s crack drafting squadTM taketh away. As it neatly excises one square of flannel here, it inserts another one, further itemising ways in which a company might reorganise itself, there. In practical terms — ones that might make a difference were they to be considered by the Queen’s Bench Division, that is — no real change between 1992 ISDA and 2002 ISDA.

Discussion

When a firm merges into, or is taken over by, another, some magical — or unexpected — things can happen. Not for nothing does the ISDA Master Agreement labour over the very description: that this might be a “consolidation, amalgamation, merger, transfer, reorganisation, reincorporation or reconstitution” — prolix even by the lofty standardsof ISDA’s crack drafting squadTM — should tell you something. Generations of corporate lawyers have forged whole careers — some never leaving the confines of their law practices for forty or more years — out of the manifold ways one can put companies together and take them apart again.

Your correspondent is not one of those people and has little more to say about mergers, except that what happens to live contracts at the time of such chicanery will depend a lot on just how the companies and their assets are being joined together or torn assunder.

If the ISDA Master Agreement and its extant Transactions carry across — which, in a plain merger, they ought to — all well and good - though watch out for traps: what if both merging companies have ISDAs with the same counterparty, but on markedly different terms? Which prevails? Do they both? Which one do you use for new Transactions? This you will have to hammer out across the negotiating table.

But in some cases, Transactions might not carry across. Perhaps the resulting entity has no power to transact swaps. Perhaps it is in a jurisdiction in which they — or ISDA’s sainted close-out netting provisions, about which so many tears and so much blood is annually spilled — cannot be enforced. Perhaps the new entity just refuses to honour them.

Merger Without Assumption addresses all of these contingencies.

This is the clause that would have been covered by Section 5(a)(ii)(2) repudiation, had the resulting entity accepted the contract at all in the first place. It can be triggered if the resulting party repudiates any outstanding Transactions under the ISDA Master Agreement (or otherwise they are not binding on it); or any Credit Support Document stops working as a result of the merger.

And “all or substantially all” means what exactly?

There’s not a lot of case law on it. Some say 90%. Some say 75%. Some people — your correspondent included — say “shoot me”.

But, interestingly, Merger Without Assumption doesn’t seem to bite where one entity transferred all of its assets, half-half, into two distinct entities. I dunno — could it happen? Search me. You’ll have to go and find one of those corporate lawyers I was talking about before to find that out. They love that kind of stuff. Template:M detail 2002 ISDA 5(a)(viii)

Subsection 5(b)

Comparison between versions

Template:M comp disc 2002 ISDA 5(b)

Discussion

Trick for young players: Force Majeure Event

Note that the 2002 ISDA includes a Force Majeure Event, using language that was already agreed and widely inserted into the 1992 ISDA Schedule prior to its publication. Because this was entered as Section 5(b)(ii), this necessitates some numbering differences between the two versions of the ISDA Master Agreement — a drafting trick for young players to watch out for.

Events of Default vs. Termination Events: Showdown

Puzzled ISDA ingénues[62] may wonder why there are Events of Default and Termination Events under the, er, eye-ess-dee-aye. In any weather, there seem to be rather a lot of them. And there is a third, hidden category: Additional Termination Events that the parties crowbar into the Schedule.

Do we really need all these[63], and what is the difference?

So, with feeling:

Events of Default...

Termination Events ...

Template:M detail 2002 ISDA 5(b)

Subsection 5(b)(i)

Comparison between versions

Template:M comp disc 2002 ISDA 5(b)(i)

Discussion

Illegality vs. Force Majeure smackdown

Like a Force Majeure Event, an Illegality may only be triggered after exhausting the fallbacks and remedies specified in the 2002 ISDA.

There is a Waiting Period before you can terminate for Illegality the 2002 ISDA

Note the effect of section 6(b)(iv)(2) in the 2002 ISDA is to impose a Waiting Period of three Local Business Days before one acquires the right to terminate on account of an Illegality. There is no such waiting period in the 1992 ISDA.

Hierarchy of Events

Under the 2002 ISDA, Section 5(c) (Hierarchy of Events) intervenes to provide that (i) Illegality trumps Force Majeure and (ii) Illegality and Force Majeure both trump the Failure to Pay and Breach of Agreement Events of Default.

Given that Illegality is no longer subject to the “two Affected Parties” delay on termination (as it was in the 1992 ISDA), this is significant. Template:M gen 2002 ISDA 5(b)(i) Template:M detail 2002 ISDA 5(b)(i)

Subsection 5(b)(ii)

Comparison between versions

Numbering Discrepancy: Note the numbering discrepancy in Section 5(b) between the 1992 ISDA and 2002 ISDA. This is caused by a new 5(b)(ii) (Force Majeure Event) in the 2002 ISDA before Tax Event, which is thus shunted from Section 5(b)(ii) (in the 1992 ISDA) to Section 5(b)(iii) (in the 2002 ISDA).

Note that, while the 1992 ISDA does not contain the concept of force majeure, there is an ISDA Illegality/Force Majeure Protocol (see here) which can be signed to adopt/incorporate the relevant parts.

Discussion

For the last word on force majeure, the JC’s ultimate force majeure clause is where it's at. Note a few caveats with regard to Force Majeure Events:

Waiting Period

Template:ISDA Waiting Period Template:M detail 2002 ISDA 5(b)(ii)

Subsection 5(b)(iii)

Comparison between versions

Numbering Discrepancy: Note the numbering discrepancy in Section 5(b) between the 1992 ISDA and 2002 ISDA. This is caused by a new 5(b)(ii) (Force Majeure Event) in the 2002 ISDA before Tax Event, which is thus shunted from Section 5(b)(ii) (in the 1992 ISDA) to Section 5(b)(iii) (in the 2002 ISDA).

No real change from the 1992 ISDA. Note, unhelpfully, the sub-paragraph reference in the 1992 ISDA is (1) and (2) and in the 2002 ISDA is (A) and (B). Otherwise, pretty much the same.

Discussion

Basically the gist is this: if the rules change after the Trade Date such that you have to gross up an Indemnifiable Tax would weren't expecting to when you priced the trade, you have a right to get out of the trade, rather than having to ship the gross up for the remainder of the Transaction.

That said, this paragraph is a bastard to understand. Have a gander at the JC’s nutshell version and you’ll see it is not such a bastard after all, then. In the context of CCP, you typically add a third limb, which is along the lines of:

(3) required to make a deduction from a payment under an Associated LCH Transaction where no corresponding gross up amount is required under the corresponding Transaction Payment under this Agreement.

Template:M gen 2002 ISDA 5(b)(iii) Template:M detail 2002 ISDA 5(b)(iii)

Subsection 5(b)(iv)

Comparison between versions

Numbering Discrepancy: Note the numbering discrepancy in Section 5(b) between the 1992 ISDA and 2002 ISDA. This is caused by a new 5(b)(ii) (Force Majeure Event) in the 2002 ISDA before Tax Event, which is thus shunted from Section 5(b)(ii) (in the 1992 ISDA) to Section 5(b)(iii) (in the 2002 ISDA).

Note the missing “indemnifiable” from the fifth line of the 2002 ISDA version and the expanded description of “merger events” towards the end of the clause.

Discussion

Template:M summ 2002 ISDA 5(b)(iv) Template:M gen 2002 ISDA 5(b)(iv) Template:M detail 2002 ISDA 5(b)(iv)

Subsection 5(b)(v)

Comparison between versions

Numbering Discrepancy: Note the numbering discrepancy in Section 5(b) between the 1992 ISDA and 2002 ISDA. This is caused by a new 5(b)(ii) (Force Majeure Event) in the 2002 ISDA before Tax Event, which is thus shunted from Section 5(b)(ii) (in the 1992 ISDA) to Section 5(b)(iii) (in the 2002 ISDA).
- Section 5(a)(viii) is Merger Without Assumption.

1992 ISDA upgrade

Even before the 2002 ISDA was published it was common to upgrade the 1992 ISDA formulation to something resembling the glorious concoction that became Section 5(b)(v) of the 2002 ISDA. The 1992 wording is a bit lame, really. See the panel below right for a snapshot of the difference

On the other hand, you could count the number of times an ISDA Master Agreement is closed out on account of Credit Event Upon Merger on the fingers of one hand, even if you had lost all the fingers on that hand to an industrial accident. So — yeah.

Discussion

Pay attention to the interplay between this section and Section 7(a) (Transfer). You should not need to amend Section 7(a) (for example to require equivalence of credit quality of any transferee entity etc., because that is managed by CEUM.

Note also the interrelationship between CEUM and a Ratings Downgrade ATE, should there be one. One can be forgiven for feeling a little ambivalent about CEUM because it is either caught by Ratings Downgrade or, if there is no requirement for a general Ratings Downgrade, insisting on CEUM seems a bit arbitrary (i.e. why do you care about a downgrade as a result of a merger, but not any other ratings downgrade?)

Hedge funds and CEUM

Really, we are a hedge fund, we’re not rated, we’re not going to be and we’re hardly going to merge, are we? and even if we did we wouldn’t do it in a way that disadvantaged existing investors. So must we really have a CEUM? We really must[68], lest the sky fall in on our heads. For it is written: it is the credit officer’s refrain. Template:M gen 2002 ISDA 5(b)(v) Template:M detail 2002 ISDA 5(b)(v)

Subsection 5(b)(vi)

Comparison between versions

Numbering Discrepancy: Note the numbering discrepancy in Section 5(b) between the 1992 ISDA and 2002 ISDA. This is caused by a new 5(b)(ii) (Force Majeure Event) in the 2002 ISDA before Tax Event, which is thus shunted from Section 5(b)(ii) (in the 1992 ISDA) to Section 5(b)(iii) (in the 2002 ISDA).

Other than the numbering discrepancy and a daring change of a “shall” to a “will”, Section 5(b)(vi) of the 2002 ISDA is the same as Section 5(b)(v) of the 1992 ISDA. That said, ATEs are likely to be the most haggled-over part of your ISDA Master Agreement.

Discussion

Additional Termination Events are the other termination events your Credit department has dreamt up for this specific counterparty, that didn’t occur to the framers of the ISDA Master Agreement — or, at any rate, weren’t sufficiently universal to warrant being included in the ISDA Master Agreement for all. While the standard Termination Events tend to be “non-fault” events which justify termination of the relationship on economic grounds, but not on terms necessarily punitive to the Affected Party, Additional Termination Events are more “credit-y”, more susceptible of moral outrage, and as such more closely resemble Events of Default than Termination Events.

Common ones include:

There is a — well, contrarian — school of thought that Additional Termination Events better serve the interests of the Ancient Guild of Contract Negotiators and the Worshipful Company of Credit Officers than they do the shareholders of the institutions for whom these artisans practise their craft, for in these days of zero-threshold CSAs, the real credit protections in the ISDA Master Agreement are the standard Events of Default (especially Failure to Pay or Deliver and Bankruptcy).

It’s a fair bet no-one in the organisation will have kept a record of how often you pulled NAV trigger. It may well be never.

“Ahh”, your credit officer will say, “but it gets the counterparty to the negotiating table”.

Hmmm.

Trick for young players

A “Termination Event” is defined as “an Illegality, a Tax Event or a Tax Event Upon Merger or, if specified to be applicable, a Credit Event Upon Merger or an Additional Termination Event”. Therefore, adding any new Termination Event must ALWAYS be achieved by labelling it a new “Additional Termination Event” under Section 5(b)(vi) (under the 2002 ISDA) or 5(b)(v) (under the 1992 ISDA), and not a separate new Termination Event under a new Section 5(b)(vii), or anything like that.

If you try to make it into a new “5(b)(vii)” it is therefore neither an “Illegality”, “Tax Event”, “Tax Event Upon Merger”, “Credit Event Upon Mergernor an “Additional Termination Event”. Read literally, is will not be caught by the definition of “Termination Event” and none of the Section 6(b) Right to Terminate following Termination Event provisions will bite on it.

I mention this because I have seen it happen. Yes, you can take a “fair, large and liberal view” that what the parties intended was to create an ATE, but, in our age of anxiety, why suffer that one?

NAV trigger ATE

A NAV trigger is the right to terminate a master agreement as a result of the decline in net asset value of a hedge fund counterparty (other counterparty types generally won't have a “net asset valueto trigger).

Like most events of default, NAV triggers are a second-order derivative for the only really important type of default: a failure to pay. A significant decline in NAV makes a payment default more likely. NAV declines in three main ways:

  • The value of assets (be they physical or derivative) declines
  • The cost of financing those assets - the leverage - increases
  • Investors withdraw money from the fund.

Prime brokers hold initial margin to protect against the first, control the second in any weather, and one would expect the third to result in overall proportionate de-risking anyway. [69] In any case, the benefit to a second order derivative close-out right is that it might allow you to get ahead of the game. If I know the default is coming (because NAV trigger, right?) why wait until a payment is due to see if I get hosed?

Because, in this age of high-frequency trading, multiple payments are due every day, and even if one isn’t, in many cases you can force one by raising initial margin.[70] All told, an actual failure to pay is deterministic. There is no argument. A NAV trigger breach — not so much.

Especially since an official NAV is only “cut” once for every “liquidity period” — monthly or quarterly in most cases — and it is hard to see how a credit officer, however enthusiastic, could determine what the net asset value of the fund was at any other time, not having knowledge of those positions held with other counterparties. On the other hand, credit officers don’t usually monitor NAV triggers anyway, so what do they care?

Key person ATE

In a gaucher times called a key man, the key person — or people — are those in a small financial services organisation who provide the lion’s share of the brains and nowse. In a hedge fund, this means the two genius ex-Goldman trading whizz founding partners.

As long as these two chaps — they tend to be chaps, though the revolution is coming — still show up for work for their colossal paycheques, the future of the organisation is relatively assured. Should one of them or, God forbid both, gallivant off to their newly-acquired Caribbean islands to play with their respective collections of racing cars, they will leave behind a bunch of mediocre financial services hacks and bullshit artists with whom neither the fund’s erstwhile clients nor its trading counterparties will any longer wish to do business.

Hence the “key person clause”, entitling one to terminate a trading arrangement should the nominated key persons bugger off. If there is more than one nominated key person expect complications are around how many of them must leave before the clause can be triggered. Should it be all of them? Any of them? A simple majority?

Negotiating a key person clause can be a fascinating exercise. Here psychology conflicts with normal imperatives of risk management because, while key person clauses undoubtedly represent an Achilles heel for a hedge fund, they play so egregiously to the principals’ egos that most will be upset the not to be asked for one. There is no better validation of one’s self-worth, after all, than to be told that without your continued personal involvement a training relationship is worthless. Template:M detail 2002 ISDA 5(b)(vi)

Subsection 5(c)

Comparison between versions

A simple piddling match between Events of Default and Illegality in the 1992 ISDA makes way for a full-blown hierarchy of competing circumstances justifying closeout of the ISDA Master Agreement in the 2002 ISDA.

Discussion

In which the JC thinks he might have found a bona fide use for the awful legalism “and/or”. Crikey.

What to do if the same thing counts as an Illegality and/or a Force Majeure Event and an Event of Default and/or a Termination Event.

Why do we need this? Remember, an Event of Default is an apocalyptic disaster scenario which blows your whole agreement up with extreme prejudice; a Termination Event is just “one of those things” which justifies termination, but may relate only to a single Transaction, and even if it affects the whole portfolio, it isn’t something one needs necessarily to hang one’s head about. (It’s hardly your fault if they go and change the law on you, is it?)

A Force Majeure Event is something that is so beyond one’s control or expectation that it shouldn’t count as an Event of Default or even a Termination Event at all — at least until you’ve had a chance to sort yourself out, fashion a canoe paddle with a Swiss Army knife, jury-rig an aerial and get reconnected to the world wide web.

Non-repudiatory Breach of Agreement

Note that the subordination of Events of Default to Illegality and Force Majeure in section 5(c)(i) specifically excludes a repudiatory Breach of Agreement as contemplated under the newly introduced section 5(a)(ii)(2), and any Credit Support Default other than a direct, non-repudiatory, default by the Credit Support Provider.

Why? Well, firstly, this is about Events of Default that are directly caused by an Illegality or Force Majeure, not simply ones which are coincidental with them. That being said, disciples of David Hume will appreciate that causal relations are not always perfectly clear, a spurious correlation can resemble causation, so there is inevitably scope for a mischievous defaulter to create confusion and angst here. Recognising this, ISDA’s crack drafting squadTM inserted some language which, in a world governed unstintingly by cold economic logic, would be redundant, but may help to put easily riled minds at rest here.

Secondly, if you have actually repudiated your contract — that is to say, point-blank refused to perform its clear terms — and, by lucky hap, your repudiation coincides with an Illegality or a Force Majeure by which you couldn’t perform it even if you wanted to, then your counterparty should not be obliged to give you the benefit of the doubt and have to close you out via the more genteel route of an Illegality Termination Event.

If you’ve thrown your toys out of the pram, expected to be spanked, that is to say.[71] Template:M gen 2002 ISDA 5(c) Template:M detail 2002 ISDA 5(c)

Subsection 5(d)

Comparison between versions

There is no equivalent provision to Section 5(d) in the 1992 ISDA, seeing as it does not contain a Force Majeure Event at all, and its conception of Illegality is far less — how shall we say? — sophisticated than the one in the 2002 ISDA.

Discussion

Upon an Illegality or Force Majeure Event, payments and deliveries are deferred until the earlier of (a) the expiry of any Waiting Period; and (b) the date on which the Illegality or Force Majeure Event is cured. Template:M gen 2002 ISDA 5(d) Template:M detail 2002 ISDA 5(d)

Subsection 5(e)

Comparison between versions

Template:M comp disc 2002 ISDA 5(e)

Discussion

In a nutshell squared: If an Affected Party’s head office is subject to a Force Majeure or Illegality, It can’t be whacked for not performing a branch’s obligations under the Section 10(a) rep.

From the “shoot me” department, this multi-line bunker-buster introduced into the 2002 ISDA which, to give it some kind of credit, doesn’t generate a great deal of comment in the course of your average negotiation. That is as likely to be because it is so stupefyingly dull that no one has summoned the fortitude to read it as it is because it is a sensible, prudent allocation of risk.

But here you are, especially for you, the Jolly Contrarian’s NutshellTM service renders it for you in emperor’s couturier style. Template:M gen 2002 ISDA 5(e) Template:M detail 2002 ISDA 5(e)

Section 6

Section 6 in a nutshell

6. Early Termination

6(a) Right to Terminate following Event of Default. If one party (“Defaulting Party”) suffers an Event of Default, the other (the “Non-defaulting Party”) may, by not more than 20 days’ notice, designate an Early Termination Date for all outstanding Transactions. If Automatic Early Termination applies to the Defaulting Party and the Event of Default it is qualifying Bankruptcy event, the Early Termination Date will occur:

(i) upon the Bankruptcy event, if under 5(a)(vii)(1), (3), (5) or (6) or if analogous, (8); and
(ii) immediately before institution of the relevant proceeding, if under 5(a)(vii)(4) or if analogous, (8).

6(b) Right to Terminate Following Termination Event.

6(b)(i) Notice. Upon becoming aware of a Termination Event the Affected Party will promptly give the other party with reasonable details of it and each Affected Transaction (or make reasonable efforts to so, if it is a Force Majeure Event).
6(b)(ii) Transfer to Avoid Termination Event
If there is a Tax Event with only one Affected Party or a Tax Event Upon Merger where the Burdened Party is the Affected Party, before designating an Early Termination Date the Affected Party must use all reasonable efforts to transfer, within 20 days of giving notice of the Termination Event, all its rights and obligations under the Affected Transactions to one of its Offices or Affiliates so that the Termination Event ceases to exist.
If it cannot make such a transfer, it will advise the other party within the 20 day period, and the other party may effect such a transfer within 30 days after the original notice of Termination Event.
Any such transfer by a party under this Section will require the of the other party’s prior written consent (which may not be withheld if the other party’s prevailing policies would permit it to enter into transactions on the terms proposed).
6(b)(iii) Two Affected Parties. If there is a Tax Event with two Affected Parties, each must use all reasonable efforts agree within 30 days after the Termination Event Notice to avoid it.
6(b)(iv) Right to Terminate
(1) Termination Events other than Illegality and Force Majeure Events: If the Termination Event still exists but:―
(A) Tax Termination Events: a neither party has managed to avoid a Tax Event or Tax Event Upon Merger as contemplated in Section 6(b)(ii) or 6(b)(iii) within 30 days of a Termination Event Notice; or
(B) Other Termination Events: there is a Credit Event Upon Merger, an Additional Termination Event or a Tax Event Upon Merger where the Burdened Party is not the Affected Party:
either party (if both are Affected Parties) or the Non-Affected Party (in any other case) may, on not more than 20 days’ notice, designate an Early Termination Date for all Affected Transactions.
(2) Illegality and Force Majeure Events: If an Illegality or Force Majeure Event still exists when its Waiting Period has expired:―
(A) Subject to clause (B) below, either party may, on not more than 20 days’ notice, designate an Early Termination Date:
(I) for all Affected Transactions, or
(II) for fewer than all Affected Transactions by specifying which Affected Transactions it wishes to terminate, effective no earlier than two Local Business Days following the effective day of its notice, as an Early Termination Date for those designated Affected Transactions only. In this case the other party may, by notice, terminate any of the outstanding Affected Transactions as of the same Early Termination Date.
(B) Where the Illegality or Force Majeure Event relates to performance under a Credit Support Document, an Affected Party may only designate an Early Termination Date following designation by the other party of an Early Termination Date, for fewer than all Affected Transactions under this Section.

6(c) Effect of Designation: If an Early Termination Date is designated:

(i) it will take place when designated, even if the event which triggered no longer exists.
(ii) no more payments or deliveries will be required under any Terminated Transactions.

Any Close-out Amount will be determined under Section 6(e).
6(d) Calculations; Payment Date.

(i) Statement. As soon as practicable following an Early Termination Date, each party will calculate its Section 6(e) amount and give the other party a statement:
(1) showing reasonable detail of its calculations;
(2) specifying any Early Termination Amount payable; and
(3) giving its bank details for payment of the Early Termination Amount.
Its records of any quotation or market data it uses will be conclusive of their accuracy.
(ii) Payment Date. An Early Termination Amount due in respect of any Early Termination Date will, together with any amount of interest payable pursuant to Section 9(h)(ii)(2), be payable
(1) when its notice is effective for an Early Termination Date following an Event of Default and
(2) two Local Business Days after its notice was effective (or, where two Affected Parties, after the second statement is effective) for an Early Termination Date following a Termination Event.

6(e) Payments on Early Termination. If an Early Termination Date occurs, the “Early Termination Amount” will be determined as follows (subject to Section 6(f)).

6(e)(i) Events of Default. On an Early Termination Date following an Event of Default, the Non-defaulting Party will determine Early Termination Amount in the Termination Currency as the sum of:
(a) the Close-out Amounts for each Terminated Transaction plus
(b) Unpaid Amounts due to the Non-defaulting Party; minus
(c) Unpaid Amounts due to the Defaulting Party.
If the Early Termination Amount is positive, the Defaulting Party will pay it to the Non-defaulting Party. If negative, the Non-defaulting Party will pay its absolute value to the Defaulting Party.
6(e)(ii) Termination Events. If the Early Termination Date results from a Termination Event:―
(1) One Affected Party. If there is one Affected Party, the Early Termination Amount will be determined as if they were Events of Default under Section 6(e)(i) (but subject to the Mid-Market Events rider below).
(2) Two Affected Parties. If there are two Affected Parties, each party will determine the Termination Currency Equivalent of the Close-out Amounts for all Terminated Transaction and the Early Termination Amount will be:
(A) the sum of
(I) half of the difference between the higher amount (determined by party “X”) and the lower amount (determined by party “Y”) and
(II) the Termination Currency Equivalent of the Unpaid Amounts owing to X minus
(B) the Termination Currency Equivalent of the Unpaid Amounts owing to Y.
If the Early Termination Amount is a positive number, Y will pay it to X; if negative , X will pay its absolute value to Y.
(3) Mid-Market Events. In either case where the Termination Event is an Illegality or a Force Majeure Event, when determining a Close-out Amount the Determining Party will use mid-market valuations that do not take the Determining Party’s own creditworthiness into account.
6(e)(iii) Adjustment for Bankruptcy. If an “Automatic Early Termination” happens, one can adjust the Early Termination Amount to reflect payments or deliveries actually made between the automatic Early Termination Date and the payment date determined under Section 6(d)(ii).
6(e)(iv) Adjustment for Illegality or Force Majeure Event. The failure by a party or its Credit Support Provider to pay an Early Termination Amount when due will not be a Failure to Pay or Deliver or a Credit Support Default if caused by an Illegality or a Force Majeure Event. The unpaid amount will:
(1) be treated as an Unpaid Amount for a subsequent Early Termination Date resulting from an Event of Default, a Credit Event Upon Merger or an Additional Termination Event affecting all outstanding Transactions; and
(2) otherwise accrue interest in accordance with Section 9(h)(ii)(2).
6(e)(v) Pre-Estimate. The parties acknowledge that:
(a) Each Early Termination Amount is a reasonable pre-estimate of loss and not a penalty; and
(b) neither party may recover any additional damages as a consequence of terminating Terminated Transactions.

6(f) An Innocent Party may, by notice, set-off any part of an Early Termination Amount payable by one party against any Other Amounts payable by the other under any other agreement, converting currencies if necessary and estimating unascertained obligations in good faith, but it must account for any difference between its estimate and the amount when it is finally ascertained.

Comparison between versions

Template:M comp disc 2002 ISDA 6

Discussion

Template:M summ 2002 ISDA 6 Template:M gen 2002 ISDA 6 Template:M detail 2002 ISDA 6

Subsection 6(a)

Comparison between versions

+++ COVID-19 UPDATE +++ COVID-19 UPDATE +++ COVID-19 UPDATE +++ See section 12 for what this all means in a time of global pandemic lockdown

See also the separate article all about Automatic Early Termination, which features in the last sentence of this Section, but deserves a page all of its own.

Those with a keen eye will notice that, but for the title, Section 6(a) of the 2002 ISDA is the same as Section 6(a) of the 1992 ISDA and, really, not a million miles away from the svelte form of Section 6(a) in the 1987 ISDA — look on that as the Broadcaster to the 1992’s Telecaster.

Discussion

Everyone’s hair will be on fire

This is likely to be a time where the market is dislocated, your credit officer is running around with her hair is on fire, your normally affable counterparty is suddenly diffident or evasive, and your online docs database has crashed because everyone in the firm is interrogating it at once.

This is also one time the commercial imperative will count for little, since you are terminating your trading relationship altogether and with extreme prejudice. Your normally iterated game of prisoner’s dilemma has turned into a single round game. Game theorists among you will know immediately that the calculus is therefore very different, and much, much less appealing.

So: good luck keeping your head while all around you are losing theirs.

Close-out sequence

Once you have designated an Early Termination Date for your ISDA Master Agreement, proceed to 6(c) to understand the Effect of Designation. Or learn about it in one place with the NC.’s handy cribsheet, “closing out an ISDA”.

The Notices provisions in Section 12 are relevant to how you may serve this notice. In a nutshell, in writing, by hand. Don’t email it, fax it, telex it, or send it by any kind of pony express or carrier pigeon unless your pigeon/pony is willing to provide an affidavit of service.

Closing out an ISDA Master Agreement following an Event of Default

Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.

In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.

So, you will need:

(i) a Failure by the Defaulting Party to make a payment or delivery when due;
(ii) a notice by the Non-Defaulting Party under Section 6(a) to the Defaulting Party that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.
(i) The standard grace periods are set out in Section 5(a)(i). Be careful here: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
(ii) So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
(iii) At the expiry of this grace period, you finally have a fully operational Event of Default. Now Section 6(a) gives you the right, by not more than 20 days’ notice[73] to designate an Early Termination Date for all outstanding Transactions. So, at some point in the next twenty days.
(iv) For this we go to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked. For it not to be (i.e., if Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.

“by not more than 20 days’ notice

What is the significance of the maximum notice period of 20 days that one may use to close out the ISDA Master Agreement? Poor defaulted Counterparty is in pieces, on its knees, bleeding out, but really, as long as it gets some notice, does it really care how much? Surely, the longer the period, the more hope you have? While the agreement remains in termination but un-terminated, en route to that crater in the ground but not there yet — the chance remains, however remote, that things will come right; that you, its counterparty, will see sense, or unexpectedly discover the one compassionate bone in your body that, until now, has gone wholly unnoticed and, in a cloying bout of clemency, will change your mind and withdraw your notice of termination? Well, a little hedge fund can dream, can’t it? So why deprive it, and yourself, of that option?

Now, this is deep ISDA lore. It is of the First Men[77] — yea, even the Children of the Forest. As such — since they didn’t have a written tradition back in 1986 and legends were passed down orally from father to son[78] and much has been lost to vicissitude and contingency — it is not a subject on which there is much commentary: That dreadful FT book about derivatives sagely notes that, usually, much less notice is given than 20 days (I mean, you don’t say) but doesn’t give a reason for this curious outer bound, in the same way it doesn’t give a reason for much else in the ISDA Master Agreement despite costing a monkey and that being its express purpose. Nor, for that matter, does the official ISDA User’s Guide to the 2002 ISDA Master Agreement.

One is just expected to know. Yet, in point of fact, no-one seems to. And no-one wants to risk looking stupid by asking, right? Well, companions, just not knowing is not how we contrarians roll. We like looking stupid. Compared with plain old ignorance, it speaks to having at least put in some effort, even if wasted: noble but futile toil is flattering in some lights. So, in the absence of a credentialised, plausible reason,[79] let us speculate.

Remember the ISDA Master Agreement was invented by banking folk: people who who view the Cosmos chiefly through the prism of indebtedness[80]. A lender whose borrower has defaulted will not dilly dally: she will bang in a default notice and seize whatever assets she can get her hand in poste haste. I lend, you owe. I don’t muck about. Breakage costs on a loan are easy to calculate and they are not especially volatile. There is nothing to be gained by waiting around: The longer I take to terminate my exposure , the larger it is likely to be.

But, but, but. ISDAs are different. They are not, principally,[81] a contract of indebtedness, and while a large uncollateralised mark-to-market exposure[82] is economically the same as indebtedness, the contract is bilateral, and who is indebted at any time is dependent on the net exposure: it can and does swing around.

Also, the mark-to-market exposure on swap transaction is a wildly volatile thing: With a loan, less so: you know you have (a) principal, (b) accrued interest and (c) break costs — the last of which might be significant for a long term fixed rate loan[83], but generally will pale in comparison to the principal sum owed.

So a swap counterparty who terminates might be out of the money, and disinclined to terminate just now, hoping that a more benign market environment might be just around the corner to dig it out of its hole so that when it does pull its trigger, the Close-Out Amount will be favourable. This is still taking quite the market punt on a bust counterparty — by means of a European option[84] — of course, and not the sort of thing a prudent risk manager would do[85], but I don’t suppose banking folk can be expected to have understood this in 1986.

Actually, even that makes little sense, since such a counterparty wouldn't be obliged to close out at all, but could just suspend its obligations under Section 2(a)(iii) — something which it can (or could, at any rate, when the notice period was devised, in 1987) do indefinitely. To be sure, a 2(a)(iii) suspension is just that — a suspension; should one come eventually to terminate the Transaction, those as-yet unperformed obligations will come back to haunt you as Unpaid Amounts, but at least here you retain control of the process and timing of close-out: it is an American option, not a European one. If you see the market moving against you, you can cash in your chips. So, ask yourself which is a bigger punt: that, the mark-to-market value you determine in 20 days — in a market that is likely to be a flaming wreck, by the way — better suits your book than the one you can actually trade on today, or on any day between now and that distant Early Termination Date?

So we get back to an alternative, disappointing explanation: It is just flannel.

Subsection 6(b)

Comparison between versions

Template:M comp disc 2002 ISDA 6(b)

Discussion

Template:M summ 2002 ISDA 6(b) Template:M gen 2002 ISDA 6(b) Template:M detail 2002 ISDA 6(b)

Subsection 6(b)(i)

Comparison between versions

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

Discussion

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 emailNatWest 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[86] like an alien invasion. Template:M gen 2002 ISDA 6(b)(i) Template:M detail 2002 ISDA 6(b)(i)

Subsection 6(b)(ii)

Comparison between versions

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.

Discussion

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 Forest. 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. Template:M gen 2002 ISDA 6(b)(ii) Template:M detail 2002 ISDA 6(b)(ii)

Subsection 6(b)(iii)

Comparison between versions

Be careful here: Under the 1992 ISDA, if your Failure to Pay is also an Illegality it is treated as an Illegality: if there are two Affected Parties you will face a significant delay when closing out. A bit of a trick for young players.

Note also that reference to Illegality has been excised from the 2002 ISDA version. They changed this because, in practice, it turned out to too be hard to implement a transfer or amendment after an Illegality. Folks realised that if an Illegality happens you don’t want to have to wait 30 days to terminate, especially if you can’t rely on 2(a)(iii) to withhold payments in the meantime.

Discussion

Handwaving appeals to one another’s good natures with this talk of reasonableness and, of course, both parties will probably be incentivised to keep the trade on foot if some unfortunate tax eventuality comes about — seeing as they were incentivised enough to start it —but ultimately, this is an agreement to agree, however you dress it up, and is as contractually enforceable as one. That is, not very. Template:M gen 2002 ISDA 6(b)(iii) Template:M detail 2002 ISDA 6(b)(iii)

Subsection 6(b)(iv)

Comparison between versions

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.

The additions for Illegality and Force Majeure in the 2002 ISDA afford spectacular insight into the paranoid mind of ISDA’s crack drafting squadTM, and the sort of rabbit hole one can find oneself falling down if one tries to over-think disaster scenarios. The contingencies the new wording addresses — none of which really bear much resemblance to the commercial world — are as follows:

  • What happens if a party early terminates only some, but not all, Affected Transactions — which, sure, it is entitled to do but nonetheless, in most cases, would be a dick move: here the terminating party must give two extra Local Business Days’ notice over what it would have to give if it were terminating all Affected Transactions, to allow the Affected Party to respond to the notice closing out the remaining Affected Transactions.
  • Being clear that where an Illegality or Force Majeure relates to a Credit Support Document, only the beneficiary[87] of the afforded by that Credit Support Document can call for early termination. This stands to reason since the guaranteed party does not itself suffer any loss as a result of the failure of that credit support document, so should not be entitled to use it as an excuse to terminate Transactions (well — not unless and until that beneficiary has been a dick as contemplated above and terminated only some of the Affected Transactions. At this point, all bets are off.

Discussion

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 squadTM’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” — 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 as 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, worked around, and dented Transactions that casn’t be panelbeaten back into shape may be surgically trimmed out, 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

  1. Tax ones: If a Tax Event or a TEUM[88] 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).
  2. Non-Affected Party ones: If it’s a CEUM[89], an ATE or a TEUM where the Non-Affected Party suffers the tax
  3. 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.

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

Subsection 6(c)

Comparison between versions

The framers of the 2002 ISDA daringly changed a shall to a will in the final line. Otherwise, identical.

Previous: 6(a) | 6(b) Next: 6(d) | 6(e)

Discussion

Once you have designated your Early Termination Date under Section 6(a), proceed directly to Section 6(e) to determine the Close-out Amount (if you are under a 2002 ISDA, or “tiresomely unlabelled amount payable upon early termination of the ISDA Master Agreement” if you a labouring under a 1992 ISDA).

Closing out an ISDA Master Agreement following an Event of Default

Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.

In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.

So, you will need:

(i) a Failure by the Defaulting Party to make a payment or delivery when due;
(ii) a notice by the Non-Defaulting Party under Section 6(a) to the Defaulting Party that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.
(i) The standard grace periods are set out in Section 5(a)(i). Be careful here: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
(ii) So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
(iii) At the expiry of this grace period, you finally have a fully operational Event of Default. Now Section 6(a) gives you the right, by not more than 20 days’ notice[91] to designate an Early Termination Date for all outstanding Transactions. So, at some point in the next twenty days.
(iv) For this we go to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked. For it not to be (i.e., if Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.

Template:M detail 2002 ISDA 6(c)

Subsection 6(d)

Comparison between versions

Comparison: Here is a comparison between the 1992 and 2002 versions.

Previous: 6(a) | 6(b) | 6(c) Next: 6(e)

Discussion

Section 6(d) is to do with working out the termination value of Transactions for which you’ve just designated an Early Termination Date: in the 1992 ISDA using Loss and Market Quotation, and all that Second Method malarkey, and in the 2002 ISDA the much neater and tidier Close-out Amount concept.

Generally, this is good fat-tail paranoia material, so once upon a time parties used to negotiate it heavily. General SME-drain from the negotiation talent pool over the years due to vigorous down-skilling means people are less fussed about it now.

A popular parlour game among those pedants who still insist on using the 1992 ISDA[95] is to laboriously upgrade every inconsistent provision in the 1992 ISDA to the 2002 ISDA standard except the one provision of the 1992 ISDA they always liked — if the pedant is in question is from the Treasury department, that will be the longer grace period in the Failure to Pay; if she is from Credit, it absolutely won’t be.

You might well ask why anyone would be so bloody-minded, but then you might well ask why anybody watches films from the Fast and Furious franchise. Because they can.

Or, possibly, to preserve the slightly more generous grace periods for Failure to Pay[96] and Bankruptcy[97] (in which case, you’d retrofit longer grace periods into the new version, wouldn’t you? But no). Section 6(d) gives the ISDA ninja a bit of a chicken-and-egg situation on close-out as, having served your Section 6(a) notice designating a point in the near future as the Early Termination Date, you must now ascertain termination values for the Terminated Transactions as of that date, before that date, but you can’t really work out their mark-to-market values at any time before that date, not being able to see into the future or anything.[98]

Anyway, that’s a conundrum for your trading people (and in-house metaphysicians) to deal with and it need not trouble we eagles of the law. For our purposes, the trading and risk people need to come up with Close-out Amounts[99] for all outstanding Transactions. Once they have done that you are ready for your Section 6(e) notice. Template:M detail 2002 ISDA 6(d)

Subsection 6(e)

Comparison between versions

6(e) Payments on Early Termination

6(e)(i) Events of Default (Early Termination Payments)
6(e)(ii) Termination Events (Early Termination Payments)
6(e)(iii) Adjustment for Bankruptcy (Early Termination Payments)
6(e)(iv) Adjustment for Illegality or Force Majeure Event
6(e)(v) Pre-Estimate (Early Termination Payments)

Early Termination Amount is not actually defined in the 1992 ISDA, but is referred to obliquely in Section 6(e) as:

...The amount, if any, payable in respect of an Early Termination Date and determined pursuant to this Section ...

Correctly, it is best referred to as a “Section 6(e) Amount” under the 1992 ISDA, although of course everyone does call it the Early Termination Amount. This inevitability was recognised in the 2002 ISDA, where it is defined in Section 6(e) as follows:

... the amount, if any, payable in respect of that Early Termination Date.

But the 2002 ISDA also has a “Close-out Amount”, so you may want to know what the difference between the Early Termination Amount and the Close-out Amount, you know, is. Yes?

Discussion

On the difference between an “Early Termination Amount” and a “Close-out Amount

The 1992 ISDA features neither an Early Termination Amount or a Close-out Amount, which many would see as a regrettable oversight. The 2002 ISDA has both, which looks like rather an indulgence, until you realise that they do different things.[100]

A Close-out Amount is the termination value for a single Transaction, or a related group of Transactions that a Non-Defaulting Party or Non-Affected Party calculates while closing out an 2002 ISDA, but it is not the final, overall sum due under the ISDA Master Agreement itself. Each of the determined Close-out Amounts summed with the various Unpaid Amounts to arrive at the Early Termination Amount, which is the total net sum due under the ISDA Master Agreement at the conclusion of the close-out process. (See Section 6(e)(i) for more on that).

Closing out an ISDA Master Agreement following an Event of Default

Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.

In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.

So, you will need:

(i) a Failure by the Defaulting Party to make a payment or delivery when due;
(ii) a notice by the Non-Defaulting Party under Section 6(a) to the Defaulting Party that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.
(i) The standard grace periods are set out in Section 5(a)(i). Be careful here: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
(ii) So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
(iii) At the expiry of this grace period, you finally have a fully operational Event of Default. Now Section 6(a) gives you the right, by not more than 20 days’ notice[102] to designate an Early Termination Date for all outstanding Transactions. So, at some point in the next twenty days.
(iv) For this we go to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked. For it not to be (i.e., if Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.

Section 6(e)(i) Events of Default (Early Termination Payments)

First terminate Transactions...

The effect of Section 6(e)(i) is that in closing out an ISDA Master Agreement, first you must terminate all Transactions to arrive at a Close-out Amount for each one.

The Close-out Amount is the replacement cost for the Transaction, assuming all payments up to the Early Termination Date have been made — but in a closeout scenario, of course, Q.E.D. some of those will not have been made — being the reason you need to close out.

Hence the converse concept of “Unpaid Amounts”, being amounts that should have been paid or delivered under the Transaction on or before the termination date, but weren’t (hence, we presume, why good sir is closing out the ISDA Master Agreement in the first place).

So once you have your theoretical replacement cost for each Transaction, you then have to tot up all the Unpaid Amounts that had fallen due but had not been paid under those Transactions at the time the Transactions terminated. These include, obviously, failures by the Defaulting Party, but also amounts the Non-defaulting Party didn’t pay when it relied on the flawed asset provision of Section 2(a)(iii) to withhold amounts it would otherwise have been due to pay under the Transaction after the default but before it was terminated.[106]

...then calculate net Early Termination Amount

The close out itself happens under Section 6(e) of the ISDA Master Agreement and the recourse is to a net sum. Netting does not happen under the Transactions — on the theory of the game there are no outstanding Transactions at the point of netting; just payables.

Therefore, if your credit support (particularly guarantees or letters of credit) explicitly reference amounts due under specific Transactions, you may lose any credit support at precisely the point you need it.

Which would be a bummer. Further commentary on the Guarantee page.

Section 6(e)(ii) Termination Events (Early Termination Payments)

Where the close-out follows a Termination Event, we are generally in “well, it’s just one of those things; terribly sorry it had to end like this” territory rather than the apocalyptic collapse into insolvency or turpitude one expects in an Event of Default, and accompanying high-dudgeon, so the path to resolution is a little more genteel, and winding. Secondly — unless it affects all outstanding Transactions, which by no means all Termination Events do — the upshot is not necessarily a final reckoning, but rather the retirement of only those problematic Affected Transactions. The rest sail serenely on. (To remind you all, the customised Additional Termination Events that the parties have imposed on each other tend to look and behave more like Events of Default. Pre-printed Termination Events have more to do with mergers, taxes and law changes that were neither party’s fault as such).

So first, who is the Affected Party, to whom the event has happened? If there is only one then the Affected Transaction termination process that upon an Event of Default and the Non-Affected Party will have the option whether or not to call the event at all, and will generally be in the driving seat if it does. If, however, the Termination Event in question is an Illegality or Force Majeure Event, there’s a further softening and the Non-Affected Party must use a mid-market levels derived from quotations which disregard the value of the Non-Affected Party’s creditworthiness or credit support — again, the reason being, “look, this is just one of those things, man”. It isn’t about you.

If both sides are Affected Parties (likely upon an Illegality or Tax Event and, to a lesser extent, a Tax Event Upon Merger each side works out its own Close-out Amounts and they split the difference.

Section 6(e)(iii) Adjustment for Bankruptcy (Early Termination Payments)

Template:Isda 6(e)(iii) summ

Section 6(e)(iv) Adjustment for Illegality or Force Majeure Event

Template:Isda 6(e)(iv) summ

Section 6(e)(v) Pre-Estimate (Early Termination Payments)

From the lady doth protest too much school of contractual drafting, a neat and theoretically vacuous attempt to ensure that Early Termination Amounts determined under an ISDA Master Agreement are not seen as (unenforceable) penalty clause, but rather a liquidated damages clause — i.e., a “genuine pre-estimate of loss” caused by a breach of contract, as enunciated by Lord Dunedin in that famous contract case on penalty clauses, Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd.

But it either is or it isn’t. As it happens, it probably is a liquidated damages clause, but the parties agreeing in a standard form that it is one doesn’t really help that analysis.

Relevance of Section 6 to the peacetime operation of the 1995 English Law CSA

The calculation of Exposure under the 1995 English Law CSA is modelled on the Section 6(e)(ii) termination methodology following a Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.

This means you calculate the Exposure as:

(a) the Close-out Amounts for each Terminated Transaction plus
(b) Unpaid Amounts due to the Non-defaulting Party; minus
(c) Unpaid Amounts due to the Defaulting Party.

This is interesting because, as of its Termination Date the Transaction may be no more, but until those final exchanges are settled the obligations they represent — “Unpaid Amounts” in the argot of Section 6(e) — still exist and are included in the calculation of the Exposure.

Now, on the day you are meant to make that final settlement, which when (ahem — if) settled, would reduce your Exposure, you will call for your Delivery Amount or Return Amount assuming it has not (yet) been paid. By the time the Credit Support adjustment has been settled, that final settlement will have happened, meaning the person who paid the adjustment will be out of pocket, and will need to call it back (using the same process).

Fun times in the world of collateral operations.

Subsection 6(e)(i)

Comparison between versions

Template:M comp disc 2002 ISDA 6(e)(i)

Discussion

First terminate Transactions...

The effect of Section 6(e)(i) is that in closing out an ISDA Master Agreement, first you must terminate all Transactions to arrive at a Close-out Amount for each one.

The Close-out Amount is the replacement cost for the Transaction, assuming all payments up to the Early Termination Date have been made — but in a closeout scenario, of course, Q.E.D. some of those will not have been made — being the reason you need to close out.

Hence the converse concept of “Unpaid Amounts”, being amounts that should have been paid or delivered under the Transaction on or before the termination date, but weren’t (hence, we presume, why good sir is closing out the ISDA Master Agreement in the first place).

So once you have your theoretical replacement cost for each Transaction, you then have to tot up all the Unpaid Amounts that had fallen due but had not been paid under those Transactions at the time the Transactions terminated. These include, obviously, failures by the Defaulting Party, but also amounts the Non-defaulting Party didn’t pay when it relied on the flawed asset provision of Section 2(a)(iii) to withhold amounts it would otherwise have been due to pay under the Transaction after the default but before it was terminated.[107]

...then calculate net Early Termination Amount

The close out itself happens under Section 6(e) of the ISDA Master Agreement and the recourse is to a net sum. Netting does not happen under the Transactions — on the theory of the game there are no outstanding Transactions at the point of netting; just payables.

Therefore, if your credit support (particularly guarantees or letters of credit) explicitly reference amounts due under specific Transactions, you may lose any credit support at precisely the point you need it.

Which would be a bummer. Further commentary on the Guarantee page.

Template:M detail 2002 ISDA 6(e)(i)

Subsection 6(e)(ii)

Comparison between versions

Template:M comp disc 2002 ISDA 6(e)(ii)

Discussion

The process of closing out an ISDA following a Termination Event and not an Event of Default.

Events of Default vs. Termination Events: Showdown

Puzzled ISDA ingénues[108] may wonder why there are Events of Default and Termination Events under the, er, eye-ess-dee-aye. In any weather, there seem to be rather a lot of them. And there is a third, hidden category: Additional Termination Events that the parties crowbar into the Schedule.

Do we really need all these[109], and what is the difference?

So, with feeling:

Events of Default...

Termination Events ...

Template:M gen 2002 ISDA 6(e)(ii) Template:M detail 2002 ISDA 6(e)(ii)

Subsection 6(e)(iii)

Comparison between versions

Template:M comp disc 2002 ISDA 6(e)(iii)

Discussion

Template:M summ 2002 ISDA 6(e)(iii) Template:M gen 2002 ISDA 6(e)(iii) Template:M detail 2002 ISDA 6(e)(iii)

Subsection 6(e)(iv)

Comparison between versions

Template:M comp disc 2002 ISDA 6(e)(iv)

Discussion

Template:M summ 2002 ISDA 6(e)(iv) Template:M gen 2002 ISDA 6(e)(iv) Template:M detail 2002 ISDA 6(e)(iv)

Subsection 6(e)(v)

Comparison between versions

Template:M comp disc 2002 ISDA 6(e)(v)

Discussion

Template:M summ 2002 ISDA 6(e)(v) Template:M gen 2002 ISDA 6(e)(v) Template:M detail 2002 ISDA 6(e)(v)

Subsection 6(f)

Comparison between versions

The 1992 ISDA does not have a specific set off provision, although it manages to define Set-off anyway.

ISDA published a suggested set-off provision in the Users Guide but no-one liked it, and several bespoke versions developed and percolated around the market. These often provided for the inclusion of Affiliates in relation to the Non-defaulting Party or Non-affected Party.

There is no Section 6(f) of the 1992 ISDA, but folks used to put in a provision into the schedule which goes something like this:

Set-off. Without affecting the provisions of the Agreement requiring the calculation of certain net payment amounts, all payments under this Agreement will be made without set-off or counterclaim; provided, however, that upon the designation of an Early Termination Date following an Event of Default, or a Termination Event under Section 5(b)(iv) or Section 5(b)(v), in addition to and not in limitation of any other right or remedy (including any right to set off, counterclaim, or otherwise withhold payment or any recourse to any Credit Support Document) under applicable law the Non-defaulting Party or non-Affected Party (in either case, “X”) may without prior notice to any person set off any sum or obligation (whether or not arising under this Agreement and whether matured or unmatured, whether or not contingent and irrespective of the currency, place of payment or booking office of the sum or obligation) owed by the Defaulting Party or Affected Party (in either case, “Y”) to X or any Affiliate of X against any sum or obligation (whether or not arising under this Agreement, whether matured or unmatured, whether or not contingent and irrespective of the currency, place of payment or booking office of the sum or obligation) owed by X or any Affiliate of X to Y and, for this purpose, may convert one currency into another at a market rate determined by X. If any sum or obligation is unascertained, X may ingood faith estimate that sum or obligation and set-off in respect of that estimate, subject to X or Y, as the case may be, accounting to the other party when such sum or obligation is ascertained. Nothing in this Agreement shall create or be deemed to create any charge under English law.”

2002 ISDA

ISDA’s crack drafting squadTM got the hint and implemented a fully-fledged set-off provision based on this language into the 2002 ISDA — but not without a little boo-boo. You can read all about it, and the boo-boo, and what people have done to fix it, at our article about that Section 6(f) Set-off provision.

Discussion

A bit of a bish in the 2002 ISDA

Set-off in the 2002 ISDA borrows from the text used to build it into the 1992 ISDA (see below) but still contains a rather elementary fluff. It imagines a world where the Early Termination Amount is payable one way, while all Other Amounts are only payable the other. Life, as any fule kno, is not always quite that convenient.

For example:


But what if there are Other Amounts payable the same way as the Early Termination Amount?


Not ideal. But fixable if you’re prepared to add some dramatically anal language:

6(f) Set-Off. Any Early Termination Amount (or any other amounts, whether or not arising under this Agreement, matured, contingent and irrespective of the currency, place of payment of booking of the obligation)” payable to one party (the “Payee”) by the other party (the “Payer”), ...

Cross-affiliate set-off

The 2002 ISDA’s Set-off provision refers to a “Payer” and “Payee”. Since either the “Payer” or the “Payee” could be the Innocent Party[114], including Affiliates into the 2002 definition becomes problematic and cumbersome.

Generally, market practice is therefore to do the following:

But cross affiliate set-off is a pretty rum affair in any case. Generally, set-off requires mutuality of payment, currency, time and counterparty, so setting off between affiliates is liable to challenge anyway (unless you have cross-guarantee arrangements). And in these modern days of bank recovery and resolution, conjoining claims between entities which are supposed to be siloed and independent isn’t really the thing.

Scope of Set-off

The 2002 ISDA set-off wording allows set-off following an Event of Default, CEUM, or any other Termination Event where there is one Affected Party and all outstanding transactions are Affected Transactions.

Often brokers will also want to set-off where there is an Illegality or ATE. There is no specific reference to all Transactions being Affected Transactions but this is implied in any set-off provision by its nature:

Template:M detail 2002 ISDA 6(f)

Section 7

Section 7 in a nutshell

7. Transfer

Subject to Section 6(b)(ii), neither party may transfer any interest in or obligation under this Agreement without the other party’s prior written consent, except:―

7(a) Due to a merger with, or consolidation of substantially all of its assets into, another entity; and
7(b) A transfer of its rights to an Early Termination Amount under Sections 8, 9(h) and 11.

Comparison between versions

No great difference between the versions of Section 7 other than those yielded by ISDA’s crack drafting squadTM satisfying its usual yen for redundancy and over-particularity.

Any right under any contract is subject to applicable law, after all, and converting “any amount payable on early termination under Section 6(e)” to “the Early Termination Amount together with any amounts payable under various other random clauses of the agreement as a result of its early termination” may be more exacting than the 1992 ISDA version, but you could as easily have fixed it just by deleting “under section 6(e)”.

Discussion

Section 7 ought to head off the temptation felt, for example, by legal eagles who should come to be handling novations in years to come to insert laborious representations and warranties that neither party has assigned any of its obligations — but knowing the sorts of legal eagles who usually get assigned to such thrilling tasks, it won’t. Nor will the fact that the 2004 ISDA Novation Definitions includes that representation. Sigh. Template:M gen 2002 ISDA 7 Template:M detail 2002 ISDA 7

Section 8

Section 8 in a nutshell

8. Contractual Currency

8(a) Payment in the Contractual Currency: Each payment under this Agreement must be made in the currency specified for that payment (the “Contractual Currency”). Payments made in a Non-Contractual Currency will only discharge an obligation to the extent the recipient, having converted it into the Contractual Currency in good faith using commercially reasonable procedures, achieves the full amount payable in the Contractual Currency.

(i) If the converted amount falls short of the amount payable in the Contractual Currency, the payer must immediately pay the necessary balance in the Contractual Currency.
(ii) If the converted amount exceeds the full amount payable in the Contractual Currency, the payee must promptly refund the excess.

8(b) Judgments. If a party obtains judgment in a Non-Contractual Currency against the other for any amount due under this Agreement and, having recovered that judgment debt, a shortfall or excess remains over the original amount due in the Contractual Currency (due to the exchange rate at which the judgment creditor, in good faith and a commercially reasonable manner, converted the judgement debt into the Contractual Currency), that judgment creditor:

(i) will be entitled to immediately receive from the other party, the value of any such shortfall in the Contractual Currency; and
(ii) must promptly refund to the other party any such excess in the Contractual Currency.

8(c) Separate Indemnities. The indemnities in this Section 8 are independent of the parties’ other obligations in this Agreement. They create separate causes of action. They will apply notwithstanding any indulgence granted to the payer by the payee, or any other claims made or judgments awarded for amounts due under this Agreement.
8(d) Evidence of Loss. Under Section 8, it will be enough if a party can show that it would have suffered a loss had it actually made the currency conversion.

Comparison between versions

But for a burst of excitement and vigour by dint of which ISDA’s crack drafting squadTM found itself desirous of moving the obvious-stating “rate of exchange” definition from Section 8(b) to the main definitions section — a result of that unnecessarily defined expression also showing up in the 2002 ISDA’s new Section 6(f) — and for a mildly different way of expressing the idea of “commercial reasonableness” — Section 8 of the 1992 ISDA survived unscathed when overhauled for the 2002 ISDA.

Discussion

Template:M summ 2002 ISDA 8

Section 8(a)

One could have stopped after the first sentence, but it is a rare ISDA ninja that can help himself babbling. ISDA ninjas would make terrible used-car salespeople.

Why the ISDA Master Agreement feels the need to contemplate the discharge of obligations in one currency by payment of an amount in another — non-compliance with the clear terms of the contract in other words — we can only guess. The payer’s ability to plow this obverse furrow still depends on the payee’s good humour: the payee is not obliged to indulge the payer, but may, by converting the tendered amount into the Contractual Currency.

If there is a shortfall, the payer must pay it immediately — fair, since the payer is craving the recipient’s indulgence in the first place and is really courting a Failure to Pay or Deliver by his cavalier behaviour.

If there is an excess, the recipient must return it promptly — also fair, seeing as she didn’t ask to be paid in Brazilian Real, and had to go to all the trouble of converting it and faffing around at the FX counter at that little shop in the arcade near Liverpool Street.

Section 8(b)

Enforcing judgments in far-flung places

It is a fact of life that when enforcing a cross-border contract, you may find yourself journeying to foreign climes in a bid to prise assets and payments out of a foreign counterparty. Places like Italy. With the best will in the world, and the firmest written intentions that the agreement be governed by English law and justiciable exclusively by her majesty’s courts[115], that may still mean engaging with, and obtaining judgments from foreign court systems, if that is where your counterparty and its financial resources are located. Those courts may be obliged to award their judgments, about your judgment, in their local currency. That exposes you to FX risk. This clause requires the parties to true up — immediately, should the windfall accrue to the Defaulting Party, only promptly if it accrues to the innocent one — by reference to a fairly determined “rate of exchange”.

Nerd’s point: This obligation is, strictly speaking, an indemnity obligation, in the true sense of that concept, in that is a payment that becomes due by reference to an externality that was not caused by breach of contract (even though originally it might have arisen out of one). So that’s nice.

Rate of exchange

Abvout that “rate of exchange” — in the 1992 ISDA defined on the spot; in the 2002 ISDA promoted to the big league and featuring in the main Definitions section. Allow the JC a pet moan. Goddamn “definitions”.

You could scarcely ask for a less necessary definition. In their hearts, you sense ISDA’s crack drafting squadTM knew this, for they couldn’t find it in themselves to even capitalise it. In the 1992 ISDA, rate of exchange didn’t even make the Definitions section, but was half-heartedly tacked onto the end of a clause halfway through the Contractual Currency section. It made it into the 2002 ISDA’s Definitions Section only because it somehow wangled its unecessary way into the new Set-off clause (Section 6(f) of the 2002 ISDA).

But if two guiding principles of defining terms are (i) don’t, for terms you only use once or twice, and (ii) don’t, if the meaning of the thing you are considering defining is patently obvious — then “rate of exchange” comprehensively fails the main criteria of a good definition.

The JC’s general view is, all other things being equal, to ease comprehension, eschew definitions.

Also, could they not have used “exchange rate”, instead of rate of exchange?

Section 8(c)

So who even knew the things in Section 8(a) and 8(b) were indemnities?

They are, in the strict literal sense of an indemnity: a contractual promise to pay a sum of money (the difference between the amount paid in the Non-Contractual Currency and the actual amount owed in the Contractual Currency) in circumstances not (strictly) amounting to a breach; they are not in the popular (but misconceived) conception of an indemnity as some kind of all-conquering smart bomb.

Now, we must hush, if we want to get home at a reasonable hour, because the Indemnity is one of the JC’s pet subjects. Get him started and that’s the evening gone.

Section 8(d)

So if your clottish counterparty can’t follow simple instructions and sends you Lire rather than Pesetas, and thereby fails to cover your loss, as long as you can prove what the exchange rate was at the time you would have exchanged it into the Contractual Currency, you can recover a loss, even if you didn’t.

Now this, to me, seems a little controversial. What if the exchange rate dropped through the floor, then recovered, and the Non-Affected Party held his nerve. Can he then cherry-pick? Template:M detail 2002 ISDA 8

Section 9

Section 9 in a nutshell

9. Miscellaneous

9(a) Entire Agreement. This Agreement is the entire agreement between the parties on its subject matter. Neither party has relied on any representation (except the actual Representations) when entering into it and each party therefore waives all rights it might otherwise have to claim it has. That said, nothing will limit either party’s liability for fraud.
9(b) Amendments. An amendment of, or waiver given under, this Agreement will only be effective if in writing and executed by each of the parties otherwise suitably electronically confirmed.
9(c) Survival of Obligations. Without prejudice to Sections 2(a)(iii) and 6(c)(ii), the parties’ obligations will survive the termination of any Transaction.
9(d) Remedies Cumulative. Except otherwise stated, a party’s rights under this Agreement are additional to any rights it happens to have at law.
9(e) Counterparts and Confirmations.

9(e)(i) Counterparts: This Agreement (and any amendment) may be executed in counterparts.
9(e)(ii) Confirmations: The parties will be bound by the terms of each Transaction from the moment they agree to those terms. They must agree a confirmation (which they will designate as a Confirmation) as soon as practicable afterwards. The Confirmation will be evidence of a binding supplement to this Agreement. They may do this electronically (including by email!).

9(f) No Waiver of Rights. A failure to exercise any right under this Agreement will not waive that right. Any exercise of a right will not be preclude any later exercise of that right, or the exercise of any other right.
9(g) Headings. Headings in this Agreement are for convenience only and should not be considered when interpreting this Agreement.
9(h)(i) Prior to Early Termination. Before an Early Termination Date is designated for the relevant Transaction:―

(1) Interest on Defaulted Payments. If a party defaults on any payment obligation, it will pay interest on the overdue amount from the original due date to the actual payment date (excluding any relevant Waiting Period), at the Default Rate.
(2) Compensation for Defaulted Deliveries. If a party defaults on any delivery obligation, it will, on demand:
(A) compensate the other party per the relevant Confirmation; and
(B) pay interest on the fair market value of the delivery obligation from the original due date to the actual delivery date (excluding any period to which clause (4) below applies), at the Default Rate. The innocent party will determine the fair market value as of the scheduled delivery date in good faith and a commercially reasonable manner.
(3) Interest on Deferred Payments. If:―
(A) a party does not pay an amount that, but for Section 2(a)(iii), would have been payable, it will, subject to (B) and (C) below, pay interest on demand from the date the amount would otherwise have been payable to the date it actually becomes payable, at the Applicable Deferral Rate;
(B) a payment is deferred under Section 5(d), the party which would otherwise have been required to make it will (as long as no Event of Default or Potential Event of Default exists, pay interest on demand from the original due date to the earlier of the date it is no longer deferred and the date on which the Event of Default or Potential Event of Default occurs, at the Applicable Deferral Rate; or
(C) a party fails (after giving effect to any deferral period set out in (B) above) to make any payment because of an Illegality or a Force Majeure Event it will, as long as the Illegality or Force Majeure Event continues and no Event of Default or Potential Event of Default exists, pay interest on demand from the date the party failed to make the payment (or, if later, the date the payment is no longer deferred) to the earlier of the date on which the Illegality or Force Majeure Event ceases and the date on which an Event of Default or Potential Event of Default occurs to that party (excluding any period in which compensation is due under clause (B) above), at the Applicable Deferral Rate.
(4) Compensation for Deferred Deliveries. If:―
(A) a party does not settle any delivery that, but for Section 2(a)(iii), it would have been required to make; or
(B) a delivery is deferred under Section 5(d); or
(C) a party fails to deliver because of an Illegality or Force Majeure Event when any applicable Waiting Period has expired,
that party will compensate and pay interest to the other party on demand (after such delivery becomes required) as required the relevant Confirmation.

9(h)(ii) Early Termination. Upon an Early Termination Date on a Transaction:―

9(h)(ii)(1) Unpaid Amounts. To determine an Unpaid Amount for that Transaction, interest will accrue on any payment obligation or the fair market value of any delivery obligation from the date the obligation was due to be performed until the Early Termination Date, at the Applicable Close-out Rate.
9(h)(ii)(2) Interest on Early Termination Amounts. If an Early Termination Amount is due it must be paid with interest in the Termination Currency from the Early Termination Date until the date it is paid, at the Applicable Close-out Rate.

9(h)(iii) Interest Calculation. Any interest under this Section will compound daily and be for the actual number of days elapsed.

Comparison between versions

Template:M comp disc 2002 ISDA 9

Discussion

Template:M summ 2002 ISDA 9 Template:M gen 2002 ISDA 9 Template:M detail 2002 ISDA 9

Subsection 9(a)

Comparison between versions

A lengthy disclaimer of any pre-contractual representations — presumably, not counting the ones patiently documented in Section 3) — is appended in the 2002 ISDA. You get the sense someone got burned in the ’90s, don’t you. Language that wounded has the air of wistful regret about it.

Discussion

What you see is what you get, folks: if it ain’t written down in the ISDA Master Agreement, it don’t count, so no sneaky oral representations. But, anus matronae parvae malas leges faciunt, as we Latin freaks say: good luck in enforcing that if your counterparty is a little old lady.

Note also that liability for a fraudulent warranty or misrepresentation won’t be excluded. So if your oral representation or warranty is a bare-faced lie, the innocent party can maybe still rely on it in entering the agreement, even if it isn’t written down, though good luck parsing the universe of possible scenarios to figure out when that qualification might bite.

Smart-arse point: A warranty is a contractual assurance, made as part of a concluded contract, and cannot, logically, be relied on by the other party when entering into the contract. An assurance on which one relies when deciding to enter into a contract is a representation.

Confirmations

The entire agreement clause is legal boilerplate to nix any unwanted application of the parol evidence rule. Which might be a problem because the time-honoured understanding between all right-thinking derivatives trading folk is that the oral agreement, between the traders is the binding legal agreement, and not the subsequent confirmation, hammered out between middle office and operations folk after the trade is done. Hasten to Section 9(e)(ii) — the Confirmation is only evidence of the binding agreement. Could that be it?

Entire agreement bunk

Section 9(a) isn’t quite as ludicrous as the Entire Agreement clause in the 2010 GMSLA,[116] in that ISDA’s crack drafting squadTM craftily included all Confirmations in the definition of “Agreement” in Section 1(c), but it is still mostly bunk, seeing as (as per the above) the Confirmation isn’t the canonical binding Transaction anyway, and besides an “Entire Agreement” that you freely concede the parties could be orally augmenting or Confirming several times a day for the hereafter really isn’t a fabulously stout hook to hang your hat on should you wish to make a point out of it in forthcoming litigation. Actually, what would be the point you would wish to make about an entire agreement in litigation? Answers on a postcard please. Template:M gen 2002 ISDA 9(a) Template:M detail 2002 ISDA 9(a)

Subsection 9(b)

Comparison between versions

9 Miscellaneous

9(a) Entire Agreement
9(b) Amendments
9(c) Survival of Obligations
9(d) Remedies Cumulative
9(e) Counterparts and Confirmations
9(f) No Waiver of Rights
9(g) Headings
9(h) Interest and Compensation (2002 ISDA only)

Discussion

ISDA’s crack drafting squadTM takes a clause which didn’t really need to be said, and converts it into a monster. If we convert this to symbolic logic it must mean this:

Effective amendment or waiver =In writing AND [EITHER executed by each party OR confirmed by exchange of [EITHER Telex OR electronic message]]

In writing” means recorded for posterity, in words ingestable by means of the eyes, as opposed to the ears. This is not the OED definition, I grant you — I made it up just now — but it zeroes in on the immutable fact that, whether it is on parchment, paper, cathode ray tube, LED screen or electronic reader, you take in writing by looking at it. Not orally — from the mouth — or for that matter, aurally — to the ears nor, in the JC’s favourite example, via semaphore, by a chap waving flags from a distant hill, but in visible sentences, made up of visual words.

So WHAT THE HELL IS “INCLUDING A WRITING EVIDENCED BY A FACSIMILE TRANSMISSION” MEANT TO ADD? What even is “a” writing? But, readers, this brief sentence gets only worse. Then it says “AND executed by each of the parties” — so what, are you saying you have to get them to sign your fax copy, or re-transmit it over a telex?

And note, email does not count as an electronic messaging system. I know it seems odd, but that is the unambiguous text in the definition of “electronic messaging system”. So a waiver of a NAV Trigger by email, even by an exchange of emails, are not strictly enforceable. Though of course waivers unsupported by consideration are generally revocable on fair notice under English law anyway.

As a result ISDA’s crack drafting squadTM can pat itself on the back for having inserted as long ago as 1992 what, at the time, was an unnecessary clause but which turned out to anticipate a rather woeful decision of the Supreme Court in 2018.

No oral modification” is a self-contradictory stricture on an amendment agreement, until 2018 understood by all to be silly fluff put in a contract to appease the lawyers and guarantee them an annuity of tedious work. But as of 2018 it is no longer, as it ought to be, a vacuous piece of legal flannel — thanks to what we impolitely consider to be an equally vacuous piece of legal reasoning by no less an eminence than Lord Sumption of the Supreme Court in Rock Advertising Limited v MWB Business Exchange Centres Limited if one says one cannot amend a contract except in writing then one will be held to that — even if on the clear evidence the parties to the contract later agreed otherwise.

This is rather like sober me being obliged to act on promises that drunk me made to a handsome rechtsanwältin during a argument about theoretical physics in a nasty bar in Hammersmith after the end-of-year do, which that elegant German attorney can not even remember me making, let alone wishing to see performed.[117] Hold my beer. Three lookouts here.

One: Email isn’t included. According to her majesty’s judiciary, email is not included and does not count as an electronic messaging system. Let your klaxons blare. But at leadst the 1992 ISDA is equivocal about it: in the 2002 ISDA it is written into the definition of “electronic messaging system” that it doesn’t include email. I know it seems absurd at first glance — some would say it seems absurd having read the whole judgment in Greenclose v National Westminster Bank plc and thought about it at length over a hearty walk in the woods — but there it is: that is the law of the land at the time of writing.

Two: This might not so much matter were it not for another spectacular outing for her majesty's judiciary[118], in which Lord Sumption decided that a “no oral modification” clause means what it says. Hitherto is had been assumed to be an easy concession to pedantic lawyers to let then can march in triumph back to their clients having had their iatrogenic way, but it now actually means something. Strictly interpreting a NOM clause probably makes sense if you are contemplating the eternal verities on the hard benches of a law library — or your judicial chambers — but it makes none if your job is to manage the cut and thrust of daily operational contract management.

To be sure, most financial institutions have a military-industrial complex handling the negotiation of ISDA Master Agreements and other trading contracts, so a formal amendment is not likely to pass without copperplate script execution in any case. And where the agreement contains a manifest error, and the parties perform to its true intent, notwithstanding misdirected written text, does this give one side a free, unconscionable option? — who can say?

And as for waivers — especially when your credit department is in the thrall of setting NAV triggers it doesn’t monitor and isn’t likely to to exercise — by the lights of this clause you must formally confirm these waivers in writing, which is a profound waste of everyone’s time.

Three: Good luck reconciling the above with the Counterparts and Confirmations clause, which says, rightly, that the binding action on a Transaction is the moment the parties first agree it — that is, as likely as not, a phone call or Bloomberg chat, or in volume products, an electronic handshake between booking systems. Since a Transaction is a modification to the ISDA Master Agreement, the words above ring a bit hollow.

BUT ANYWAY. Template:M detail 2002 ISDA 9(b)

Subsection 9(c)

Comparison between versions

Section 9(c) is identical as between 1992 ISDA and the 2002 ISDA.

Discussion

In which ISDA’s crack drafting squadTM grapple with the existential question: if I close out all my Transactions because the other guy fundamentally breached the contract, can I still rely on the good bits of the contract to manage my risk position and enforce my bargain?

We are deep into ontological territory here, fellows.

The subtle difference between an event of default and a fundamental breach of contract

A fundamental breach of contract is a failure to perform its terms in such a way that deprives the other party of the basic benefit of the contract. This could be anything — like a duck, you know it when you see it — but beyond being an outright failure to perform one’s material obligations it need not, and logically cannot, be comprehensively articulated in the contract.

An event of default, on the other hand, is articulated, usually at painful length, in the contract, which then contains detailed provisions setting out what should happen, to whom, by when, if an event of default befalls either party.

Now while the same set of circumstances might be an event of default and a fundamental breach of contract — almost certainly will be, in fact — treating a case as an event of default is to see it as “infra-contractual action”,[119] contemplated by and provided for within the four corners of the contract; while treating it as a fundamental breach is thereby to cast the whole contract into the fire. For what good are the promises in it, after all, if the other fellow won’t keep them?

Thus, alleging fundamental breach is to terminate the contract with prejudice to your remaining rights under it, and to prostrate yourself at the feet of the Queen’s Bench Division for redress by way of damages, being the liquidated net present value of those remaining rights, determined by reference to the golden streams of common law precedent, whose terms might not be quite as advantageous to you as those you might have asked for were you able to agree them in advance. These common law principles are about the contract, they are not rules of the contract. The contract itself it a smoldering husk.

Thus, an event of default leaves the contract on foot, while you exercise your options to extract the value of your party’s commitments under it, without resorting to the courts. A fundamental breach requires the intervention of our learned friends

Now in most scenarios, which route you take might not make a whole heap of difference: In a contract between a supplier and consumer, or lender and borrower, there is a fundamental asymmetry you can’t cure with fancy words: if the guy owes you stuff, or money, that he hasn’t ponied up, you will need the court’s help to get it out of him. But master trading contracts are normally more bilateral than that: you have exposure, I have collateral. Maybe, the next day, I have exposure and you have collateral. Close-out is a self-help option, and it is quicker and cleaner than praying for relief from the QBD. But exercising it requires the contract to still be there.

Netting and close-out

Why should this matter here? Well, because netting, in a word. Here the fabulous nuances of the ISDA Master Agreement come into play. Close-out netting — as we all know, a clever if somewhat artificial and, in practical application, quite tedious concept — is not something that just happens by operation of the common law. Set-off, which does, is a narrower and flakier thing requiring all kinds of mutuality that might not apply to your ISDA Master Agreement.

The contractual device of close-out netting, by contrast, relies on the patient midwifery of ISDA’s crack drafting squadTM and the sophisticated contrivances they popped into the ISDA Master Agreement: especially the parts that say all Transactions form a Single Agreement, and those long and dusty passages in Section 6 which painfully recount how one terminates those Transactions and nets down all the resulting exposures should things go tits up.

Now, it really wouldn’t do if one were found to have thrown those clever legal artifacts on the fire before seeking the common law’s help to manage your way out of a portfolio with a busted counterparty would it. Section 9(c) is there to avoid the doubt that you might have done so: Just because you’ve declared an Early Termination Date, that doesn’t mean all bets are off. Just the live Transactions.

As far as the JC can see, through his fogged-up, purblind spectacles, this doubt, like most, didn’t need avoiding and shouldn’t have been present in the mind of a legal eagle of stout mental fortitude: it is clear on its face that terminating a transaction under pre-specified mechanism in the contract is not to cancel the contract and sue for damages, but to exercise an option arising under it, and all your mechanical firepower remains in place.

Indeed, there is no mechanism for terminating an ISDA Master Agreement itself, at all. Even in peace-time. This has led at least one commentator to hypothesise that this proves that derivatives trading is all some kind of Illuminati conspiracy. Template:M gen 2002 ISDA 9(c) Template:M detail 2002 ISDA 9(c)

Subsection 9(d)

Comparison between versions

Template:M comp disc 2002 ISDA 9(d)

Discussion

Template:M summ 2002 ISDA 9(d) Template:M gen 2002 ISDA 9(d) Template:M detail 2002 ISDA 9(d)

Subsection 9(e)

Comparison between versions

But for some finnickering around at the margin — allowing Confirmations to be exchanged by telex, fax or email; that kind of thing — the 2002 ISDA is substantially the same as for the 1992 ISDA

Discussion

In which the ISDA Master Agreement deals with the pointless topic of counterparts, and the workaday one of Confirmations.

Section 9(e)(i) Counterparts

There is an impassioned essay about the idiocy of counterparts clauses elsewhere.[120] For now, just know this:

TL;DR: Away from the gripping world of land law, a counterparts clause is as useful as a chocolate tea-pot.

Outside the arcane and stupefying word of conveyancing, a “counterparts” clause is a waste of trees. Indeed: even there, it is a waste of trees, because if you need to have everyone sign the same bit of paper, a counterparts clause, attesting that they don’t have to, won’t work. But do not let that stop your legal eagles insisting on one, on pain of cratering the trade altogether, of course: a fellow has to put food on the table for his younglings.

Black’s Law dictionary has the following to say on counterparts:

“Where an instrument of conveyance, as a lease, is executed in parts, that is, by having several copies or duplicates made and interchangeably executed, that which is executed by the grantor is usually called the “original,” and the rest are “counterparts;” although, where all the parties execute every part, this renders them all originals.”

Sometimes it is important that more than one copy of a document is recognised as an “original” — for tax purposes, for example, or where “the agreement” must be formally lodged with a land registry. But these cases, involving the conveyance of real estate, are rare — non-existent, indeed, when the field you are ploughing overflows with flowering ISDA Master Agreements, confidentiality agreements and so on.

Section 9(e)(ii) Confirmations

Trade versus confirmation: celebrity death-match

If a trader agrees one thing, and the confirmation the parties subsequently sign says another, which gives? A 15 second dealing-floor exchange on a crackly taped line, or the carefully-wrought ten page, counterpart-executed legal epistle that follows it?

TL;DR: The original oral trade prevails.

The confirmation is evidence of the transaction, but it does not override the original transaction terms, if they are different.

That is, the binding trade may be a phone call or a bloomberg chat. (This sits kind of uneasily with that Entire Agreement clause, but still.)

If there is a dispute about the terms of your confirmation, you are going to have to pull the tapes.

There are some very good reasons for this. Firstly, the original trade was done by the trader with the trading mandate. The confirmation will be punted out by some dude in ops who might not be able to read the trader’s handwriting. Ops can and will get things wrong. That is correctable on the record. The trader doesn’t “get things wrong”. If she does, you’re into mistake territory. The law on contractual mistakes is beloved by students of the law and misunderstood by everyone else. But, generally, if the trader erroneously executes a trade, and the trader’s counterparty understands it correctly, the trader, and the firm she works for, will be bound by the error. That’s not a contractual mistake. It’s just a bad trade.

By contrast, a settlements and reconciliations dude who sends out a confirm which carelessly misinterprets the trade log is not making a contractual mistake: he is incorrectly recording the contract. That wasn’t the trade (good or bad) that the trader did.

Similarly, the reconciliations dude who sends out a confirm which corrects an error made by the trader has no mandate to make that change. The error is the trader’s. The trader should live with it, and throw herself at the mercy of the jurisprudence of contractual mistakes if need be: it is not for said reconciliations dude to pull her out of a hole.

Dare we mention ... email?

Note also the addition of e-mail as a means of communication to the 2002 ISDA (email not really having been a “thing” in 1992). This caused all kinds of fear and loathing among the judiciary, when asked about it, as can be seen in the frightful case of Greenclose v National Westminster Bank plc.Oh dear, oh dear, oh dear.

Timely confirmation regulations and deemed consent

Both EMIR and Dodd Frank have timely confirmation requirements obliging parties to have confirmed their scratchy tape recordings within a short period (around 3 days). This fell out of a huge backlog in confirming structured credit derivatives trades following the Lehman collapse.

Roger Moore indahouse

Lastly, a rare opportunity to praise those maestros of legal word-wrangelry, ISDA’s crack drafting squadTM. In Section 9(e)(ii), they contemplate that one might agree a Transactionorally or otherwise”. This is a smidgen wider than the usual legal eagle formulation of orally or in writing. It shows that while the swaps whizzes were conservative about how to close out a Transaction, when putting one on you are constrained only by the bounds of your imagination and the limits of interpersonal ambiguity: not just written words, nor even oral ones, but the whole panoply of possible human communications: semaphore, naval flags, Morse code, waggled eyebrows, embarrassed smiles and any other kinds of physical gesture. Template:M gen 2002 ISDA 9(e) Template:M detail 2002 ISDA 9(e)

Subsection 9(f)

Comparison between versions

Nothing to see here, folks: Section 9(f) in the 2002 ISDA is the same as Section 9(f) in the 1992 ISDA.

Discussion

Waiver: a place where the laws of the New World and the Old diverge. Does one really need a contractual provision dealing with the consequences of a fellow’s good-natured indulgence when carrying on commerce under an ISDA Master Agreement? Those with an English qualification will snort, barking reference to Hughes v Metropolitan Railway and say this Section 9(f) is inconsequential fluff that goes without saying; those acquainted with the Uniform Commercial Code and the monstrous slabs of Manhattan will tread more carefully, lest they create a “course of dealing”.

Since the ISDA Master Agreement was designed with either legal system in mind, ISDA’s crack drafting squadTM came up with something that would work in either. To be sure, it is calculated to offend literary stylists and those wholse attention span favours minimalism amongst those who ply their trade in the old country, but it does no harm.

Different approaches to evidence of the contract in the UK and US

England and the US have taken different paths when it comes to respecting the sanctity of that four-cornered document representing the contract. Whereas the parol evidence rule gives the written form a kind of “epistemic priority” over any other articulation of the abstract deal in the common law, in the new world greater regard will be had of how the parties behave when performing their contract, and less significance on what at the outset they wrote down.

So whereas in England action to not insist upon strict contractual rights will have scarce effect on those rights (at best a waiver by estoppel might arise, at least until it is withdrawn[121]), in the United States Uniform Commercial Code[122] a “course of dealing” between the parties at variance with the written terms of their bargain will tend to override those written terms. Thus, by not insisting on the strict terms of her deal, an American risks losing that deal, and will be taken by the course of dealing to have agreed something else; whereas an Englishman, by granting such an indulgence, at worst suspends his strict contractual rights but does not lose them.

In this way the parol evidence rule is less persuasive in American jurisprudence than in British.
Template:M gen 2002 ISDA 9(f) Template:M detail 2002 ISDA 9(f)

Subsection 9(g)

Comparison between versions

Yet more unimpeachably excellent work from the boys of ’92. No changes here in the 2002 ISDA.

Discussion

So suddenly, in Section 9(g) of all places, the members of ISDA’s crack drafting squadTM wake up out of their collective fever dream, and this is what they say: It’s like, “okay, so we wrote them; we did put them here — hands up, we admit it — but we don’t mean anything by them”. And what is a fellow to make of the headings before Section 9 that, short days ago, being a logical fellow, I read, enjoyed and imbued with symbolic meaning? Am I supposed to just throw that crystalline construct away now? It just seems such a waste.

Don’t you just love lawyers? Template:M gen 2002 ISDA 9(g) Template:M detail 2002 ISDA 9(g)

Subsection 9(h)

Comparison between versions

There is no strict equivalent to Section 9(h) in the 1992 ISDA. But see Section 2(e), which is a half-arsed attempt at the same thing.

Friends of the JC will know that “half-arsed” isn’t always bad, of course — it can be quite good, in fact, characterising as it does the sum total of the JC’s paltry achievements on this barren rock — and in any case it leaves something to the imagination and we all like a little private intellectual space to indulge our whims and fantasies every now and then, don’t we?

Besides, as you may come to see as you step through this monstrosity, going to town on devilish details leads you directly into the “I’m sorry I asked” file.

Are you sorry yet? Well, you did ask.

9 Miscellaneous

9(a) Entire Agreement
9(b) Amendments
9(c) Survival of Obligations
9(d) Remedies Cumulative
9(e) Counterparts and Confirmations
9(f) No Waiver of Rights
9(g) Headings
9(h) Interest and Compensation (2002 ISDA only)

Discussion

Template:M summ 2002 ISDA 9(h) Template:M gen 2002 ISDA 9(h) Template:M detail 2002 ISDA 9(h)

Section 10

Section 10 in a nutshell

10. Offices; Multibranch Parties

10(a) If this Section applies, whenever a party enters a Transaction through a branch Office, it represents that recourse against it will be the same as if it had entered through its head office (subject to any Waiting Period for an Illegality or a Force Majeure Event).
10(b) If a party is a Multibranch Party it may, subject to clause 10(c) below, enter into and book Transactions and make and receive payments through Office listed for that party in the Schedule.
10(c) The Office through which a party enters into a Transaction will be specified in the Confirmation or, if not specified, that party’s head office. The specified Office will also be the Office in which that party books and makes and receives payments and deliveries under Transaction. Except to make a Transfer to Avoid Termination Event neither party may change its specified Office for a Transaction without the the other’s prior written consent.

Comparison between versions

Template:M comp disc 2002 ISDA 10

Discussion

Section 10 of the ISDA Master Agreement allows parties to specify whether they are Multibranch Parties. Electing “Multibranch Party” status allows you to transact out of the named branches of the same legal entity. Details fans will immediately note that, from the point of view of legal and corporate philosophy — surely a subject dear to every attorney’s heart — the differing branches of a legal entity have no distinct legal personality any more than does a person’s arm or leg have different personality from her head. So being a “multibranch” party seems immaterial.

Taxation

Those details fans will have overlooked the strange, parallel universe of taxation. Here physical presence and not legal personality is what matters. Specifying that your counterparty may trade from its offices in, for example, Prague, Kabul or The Sudan[123] may impact the tax payable on payments under the relevant transactions under the ISDA. Where both parties are multibranch parties and have numerous overseas branches, a complex multilateral analysis of all the different permutations is assured.

It is basically a withholding tax gross-up risk. If withholding tax arises on a payment made through your office in Tel Aviv, and the counterparty hasn’t provided evidence of an exemption from withholding, it may argue that we have to gross-up the payment because we did not disclose that we would make payments from Tel Aviv and had we, they would have proved their exemption. So failing to disclose that ILS payments will originate from Israel, may be a material misrepresentation by omission.

Therefore, a double-jeopardy: counterparties may refuse to make the necessary Payee Tax Representation because they didn’t think it would be needed. So, no Payee Tax Representation + no Multibranch ISDA election = potential withholding tax gross up or a possible Misrepresentation Event of Default.

Now you could disclose the branch in a Confirmation (but good luck remembering to do that, and you may not have one in an electronically booked Transaction), or you could inject more detailed representations in Part 5 — but none is as simple as putting “Tel Aviv” in the Multibranch election.

Must you complete onboarding in each jurisdiction though?

Yes — and no. A case where the operational reality trumps the legal theory. If you have a Multibranch ISDA that lists, say, Prague, The Sudan[124] and Wellington, do you need to onboard the client in each of those jurisdictions? Students of onboarding will recognise this as a collossal disincentive to adding branches willy-nilly, but that legal implication will typically depend on an operational setup in the broker’s systems without which it won’t be possible to book a trade in that jurisdiction whatever the legal docs say. So look upon the legal contract as permissive; the thing that will drive your KYC obligations and trigger the onboarding onslaught will be opening an account in your systems at a later date.

Netting

While, by dint of the legal personality, it wouldn’t make any difference under English or New York law, and really shouldn’t anywhere else, there are those jurisdictions which are not so theoretically pure in their conceptualisation of the corporate form. Your counterparty may have the misfortune to be incorporated in such a place.

If so, the validity of close-out netting against that entity may indeed depend on the branch from which it transacts - and indeed there is a possibility that the governing law of the jurisdiction of the branch may endeavour to intervene (particularly relevant if it has assets). Another reason, perhaps, to disapply the “multibranch party” for a counterparty incorporated in such a jurisdiction. The way to check this is at the netting opinion review sheet contains the following question:

Does the opinion confirm that close-out netting under the agreement is enforceable notwithstanding the inclusion of branches in non-netting jurisdictions? Yes/No

Template:M detail 2002 ISDA 10

Section 11

Section 11 in a nutshell

11 Expenses

A Defaulting Party will on demand indemnify the Non-Defaulting Party for all reasonable costs — including Stamp Tax — that the Non-Defaulting Party incurs in closing out Transactions and enforcing its rights against the Defaulting Party.

Comparison between versions

Observers will note that, but for the odd comma, Section 11 in the 1992 ISDA and the 2002 ISDA are identical. And deliciously brief. Not that they couldn’t be improved, of course; they just weren’t. The dear old Jolly Contrarian has improved it for you: in the panel top left.

Discussion

An indemnity is all very well ...

Bear in mind, also, that your operating theory here is that your counterparty is a Defaulting Party — i.e., it is broke. So while it’s a fine thing, this indemnity might not be of much practical use.

Not covered in the Close-out calculation?

No. The “Expenses” referred to in this provision would not be captured by the definition of “Close Out Amount” or “Early Termination Amount” because, Q.E.D., they arise only once that amount has been determined and the Non-Defaulting Party is in the process of collecting it.

Stamp Tax and Section 4(e)

In the limited circumstance of default, this section modifies the arrangement for who pays Stamp Tax as set out in Section 4(e) (which says it is the person whose tax residence precipitates it).

Applies to Events of Default, not Termination Events

This section applies only following an Event of Default, and not on a termination following an Termination Event. There is some cognitive dissonance there: while Events of Default in the main are meant to be more worthy of outrage than Termination Events — thereby justifying stentorian measures to recover losses and costs as a result — some Termination Events, and most Additional Termination Events — are credit- and solvency-related, thus equally deserving of the kind of opprobrium that would warrant on on-slapping of an indemnity. Template:M detail 2002 ISDA 11

Section 12

Section 12 in a nutshell

12. Notices

12(a) Effectiveness. Any communication under this Agreement may be given in any manner described below (except that communications about Events of Default and Termination Events or Early Termination may not be given by electronic messaging system or e-mail) as set out in the Schedule) and will be effective when delivered:―

(i) By hand: when delivered;
(ii) By telex: are you kidding me? Who has a telex these days? OK when the recipient’s answerback is received;
(iii) By fax: FAX??? When were you born Grampa? Ok when received in legible form (the burden of proof being on the sender and, no, a transmission report won’t do);
(iv) By registered mail: when delivered (or when delivery is attempted);
(v) By electronic messaging system: when received; or
(vi) By e-mail: when delivered delivered,

unless delivery or receipt happenens outside ordinary business hours on a Local Business Day, in which case it will be deemed effective on the following Local Business Day.
12(b) Change of Details. Either party may change its contact details by notice.

Comparison between versions

The major change between the versions of Section 12 (Notices) was the 2002 ISDA’s inclusion of e-mail as a means of communication in addition to the 1992 ISDA’s electronic messaging system. Also, fax and electronic messaging system are not permitted means of serving close-out communications (i.e., under Sections 5 and 6) under the 1992 ISDA, but fax is permitted under the 2002 ISDA, whereas electronic messaging system and email are not. Got all that?

Discussion

Who would have thought a Notices provision would be so controversial? Especially the question, “what is an electronic messaging system”?

No-one, it is humbly submitted, until Andrews, J. of the Chancery Division, was invited to opine on Greenclose v National Westminster Bank plc, the kind of “little old lady” case that makes bad law.[125] The learned judge does nothing to dispel the assumption that lawyers are technological Luddites who would apply Tip-Ex to their VDUs if they didn’t have someone to do their typing for them (and if they knew what a VDU was).

For there it was held that email is not an “electronic messaging system and, as such, was an invalid means for serving a close-out notice under the 1992 ISDA, which doesn’t mention email. Read in depth about that case here.

And that was before the entire, interconnected world decided, as an orchestrated whole, to cease the conduct of the business as a physical idea for an indefinite period in early 2020. Suddenly, a widely-used and, it was assumed, well-tested notices regime started to look like it might not work.

Oh, and another thing: who seriously has a telex in this day and age?

Mandatory, or not?

Section 12 specifies a variety of different formats by which a party “may” deliver notices under the ISDA Master Agreement. Ordinarily “may” implies discretion and optionality on a party, such that if it wishes it might choose something different. We have waxed lyrical elsewhere about the potential redundancy of such optional clauses.[126] However, this is not how Andrews J saw this particularmay” in the idiosyncratic, but unappealed, case of Greenclose. This “may” means “must” and, as long as Greenclose remains the unchallenged last word in British jurisprudence, it excludes any other means of delivering a notice. Since hand-delivery and delivery by courier are mentioned but the ordinary post isn’t, this probably rules it out. (But if it’s important, who would use snail mail anyway?)

On the other hand it hardly needs to be said that all of the ordinary day-to-day communication under the ISDA Master Agreement between trading and back-office staff of each party — inconsequential matters like trading, payments, settlements, reconciliations, and margin — will happen by telephone and email, in naked disregard for the terms of the ISDA Master Agreement which, at that point, will be languishing languishing unobserved in an electronic document repository to which operations staff might not even have access. This somewhat gives the lie to Greenclose’s rather quaint apprehensions about how ISDA Master Agreements operate in practice.

Close-out notice restrictions

However curious Andrews J’s reasoning on “may”, note the overriding restriction on forms of notice for closing out: no email, no electronic messages. But note another dissonance: in the 1992 ISDA, close-out notification by fax was expressly forbidden; in the 2002, it is not: only electronic messaging systems and e-mail are verboten. Ironic, seeing how faxes have got on as a fashionable means of communication in the decades since they were sophisticated enough to be a plot McGuffin for a John Grisham novel.

Deliver

The Cambridge Dictionary says that to “deliver” is “to take goods, letters, parcels, etc. to people’s houses or places of work”.[127]

Merriam Webster says it means “to take and hand over to or leave for another”.[128]

The Collins Dictionary of British English, in a rather modishly modern English format, tells us “If you deliver something somewhere, you take it there”.[129]

A bit more challengingly, the Lexico Oxford Dictionary says it means “bring and hand over (a letter, parcel, or goods) to the proper recipient or address”. Oxford’s language suggests a “handing” from sender to recipient, though a commonsense application of delivery through a letterbox to an address says the only “hands” involved are the sender’s.

An agent for the recipient does not need to be there; just that the notice is conveyed to the appointed place. It is no good refusing to answer the door, hiding behind the sofa or blocking up your letterbox with Araldite: if the sender’s agent brings a notice to your designated address, even by regular post, the sender has “delivered” it.

If it is, literally, impossible to arrange even an agent to hand-deliver a package, what then? Before the spring of 2020, most learned commentators would have regarded such a scenario as so absurd as to not dignify an answer. By April, ISDA was seeking advice about it.

Email vs electronic messaging system

A John Grisham McGuffin yesterday. well, in about 1986 actually.

The well-intended and, we think, presumed harmless — even modern — addition of email in the 2002 ISDA, in addition toelectronic messaging system”, persuaded the Chancery Division of the High Court to conclude that “electronic messaging system” and “email” are mutually exclusive things, rather than a basic commentary on ISDA’s crack drafting squadTM inability to let things go — a conclusion which the JC finds hard to accept, as you will see if you read the Greenclose v National Westminster Bank plc case note.

CSA

Note that the 1995 English Law CSA subjects its notice provisions to this provision (see Paragraph 9(c) and 11(g).

Closeout in a time of global mass-hysteria

By March 2020, competent authorities worldwide were taking steps previously unthinkable outside a time of war to prevent the spread of a virus pandemic. Assuming you were not comatose throughout this period you may remember it. Some regulatory action was so draconian to raise a possibility that no means of service of a close-out notice under an ISDA Master Agreement, as documented, would be even possible.

Here we see the unintended consequence of ISDA’s crack drafting squadTM’s technophobia as regards email and electronic messaging systems writ large: with all souls in the industry forced to operate with paper bags on their heads from man-caves, dens, studies and dining room tables in the world’s swankier neighbourhoods, and literally no-one in the office — remote working might be the new normal now, but it was unthinkable, pandemic or no, when they published the 2002 ISDA eighteen years ago — and jackbooted goons patrolling the financial services district picking off escaping morlocks and firing warning shots at couriers, suddenly this disproportionate focus on the risks of service by email — the one means of communication left that we are safe to rely on — seems unfortunate.

ISDA a commissioned learned memorandum, which is worth a read if you can get behind the paywall — though one clarification worthwhile: a firm can’t really steal an option by requiring you to deliver your notice to “Marjory the Teal-lady in her kitchenette on the 14th floor,” the cupboard under the stairs or so on, and then point blank refuse to let you past the security barriers with your envelope. But in a multi-tenanted building, if your counterparty is a couple of guys with a spreadsheet and a high-speed connection to the LSE, and they are stuck in a small office on the fourth floor of a building with no communal reception, you might have a problem — at least in a time of force majeure or lockdown.

What terms can’t be implied

Let’s start with the easy part: the ISDA Master Agreement is clear: communication of close-out notices and related items by electronic messaging system or email[130] is not permitted. The law relating to implied terms in contracts is settled: whatever else one can do to give business efficacy to the agreement, one can’t imply a term in a contract that contradicts its express terms. So no electronic messaging under either, no email under the 2002 ISDA, and as for email under the 1992 ISDA — well, punk: are you feeling lucky?

What terms can be implied?

This will depend to an extent on the edition of your ISDA Master Agreement and law you have chosen to govern it, but probably not much: English law and New York law, by their own idiosyncratic routes, tend to arrive at more or less the same place: You are likely to be able to imply a term allowing an alternative means of delivering close-out notices provided that:

(i) delivery by any of the means set out in the contract is impossible (i.e., not just impracticable or expensive — though given the sums usually at stake when closing out an ISDA Master Agreement, it is hard to see how serving a notice could be prohibitively expensive);
(ii) that form of notice is commercially reasonable and no less likely to be actually received by the counterparty then one of the specified forms in the agreement; and
(iii) the selected form of notice is not expressly barred by the terms of the ISDA Master Agreement.

These musings have not been approved by the JC’s opinion committee — because it doesn’t have one — is not based on common law so much as common sense and, as with every other pearl that drops from the JCs’ honeyed lips is not legal advice, and should you rely on it to your detriment, that will be your hard cheese.

Look out: Protocol Ahoy

In any case, Mystic Meg here says, look out for the 2021 ISDA Notices In Time Of Mayhem, Pandemic, And War Protocol. Some aspects that protocol might like to consider:

  • Clarifying where delivery needs to be made: Recrafting Section 12 so that delivery need only be made to the public external part of the defaulting party’s place of business,[131] with no need for a human “receiver” as such, or to reach some internal sub-division in the organisation. Some firms like notices to be delivered to “the legal department” or “the fourth floor”, or another arbitrary sub-division of its operation. Given how apt these arrangements are to change, an alert negotiator should, of course, decline any such designations, but that is not always possible.[132] But any firm’s organisation — usually so Byzantine as to be impenetrable even from the inside — is beyond its swap counterparties’ control (and comprehension) and they should certainly not be disadvantaged because of it;
  • Evidence of receipt: Allowing any form of communication, whether or not now in existence, including email, where the delivering a party has evidence of receipt, to the extent of the evidence of that receipt. This puts the onus on the delivering party to ensure that the message really is transmitted, without being ankle-tapped by silly formal requirements. At the end of the day, if you can prove the guy on the desk at your counterparty actually did receive the message (for example, by replying to it), even if by email, it is hard to see any equitable justification for holding the notice invalid.

Section 13

Section 13 in a nutshell

13. Governing Law and Jurisdiction

13(a) Governing Law. The governing law will be set out in the Schedule.
13(b) Jurisdiction. For any proceedings under this Agreement (“Proceedings”), each party irrevocably:―

13(b)(i) submits:―
(1) if the Agreement is governed by English law, to the non-exclusive jurisdiction of the English courts (unless the Proceedings involve a Convention Court, in which case it will be the exclusive jurisdiction of the English courts); or
(2) if this Agreement is expressed to be governed by the laws of the State of New York, to the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court located in Manhattan;
13(b)(ii) waives (i) any objection to the laying of venue of any Proceedings brought in any such court, (ii) any claim that the Proceedings have been brought in an inconvenient forum and (iii) the right to argue that such court has no jurisdiction; and
13(b)(iii) agrees that Proceedings brought in one jurisdictions will not preclude Proceedings in any other jurisdiction.

13(c) Service of Process. Each party appoints any Process Agent specified for it in the Schedule to receive service of process in any Proceedings. If a Process Agent cannot act, the appointing party must tell the other party and within 30 days appoint an acceptable substitute. The parties consent to service of process by hand, fax or registered mail per Section 12. This clause does not stop parties serving process in any other permissible manner.
13(d) Waiver of immunities. Each party irrevocably waives all sovereign immunity relating to any Proceedings and agrees not to claim any such immunity in any Proceedings.

Comparison between versions

Template:M comp disc 2002 ISDA 13

Discussion

Template:M summ 2002 ISDA 13 Template:M gen 2002 ISDA 13 Template:M detail 2002 ISDA 13

Section 14

Section 14 in a nutshell

14. Definitions

Additional Representation” is defined in Section 3.
Additional Termination Event” is defined in Section 5(b).
Affected Party” is defined in Section 5(b).
Affected Transactions” means:

(a) for an Illegality, Force Majeure Event, Tax Event or TEUM, all Transactions affected by the Termination Event (and if it is an Illegality or Force Majeure Event that affects Credit Support Document covering only some Transactions, those Transactions) and
(b) for any other Termination Event, all Transactions.

An “Affiliate” of an entity is another entity that controls, is controlled by, or is under common control with, that entity, where to “control” means to own a majority of an entity’s voting power.
Agreement” is defined in Section 1(c).
Applicable Close-out Rate” means:—

(a) on an Unpaid Amount:—
(i) if the Defaulting Party’s obligation, the Default Rate;
(ii) if the Non-defaulting Party’s obligation, the Non-default Rate;
(iii) if a deferred obligation under Section 5(d), if there is no Defaulting Party during the deferral period, the Applicable Deferral Rate; and
(iv) in any other case following a Termination Event (except interest which accrues under (iii) above), the Applicable Deferral Rate; and
(b) on an Early Termination Amount:—
(i) from the Early Termination Date until the Early Termination Amount is payable:—
(1) if payable by a Defaulting Party, the Default Rate;
(2) if payable by a Non-defaulting Party, the Non-default Rate; and
(3) in all other cases, the Applicable Deferral Rate; and
(ii) from the date the Early Termination Amount is payable until it is actually paid:—
(1) if unpaid because of an Illegality or Force Majeure Event the Applicable Deferral Rate;
(2) if payable by a Defaulting Party (excluding any period where (1) above applies), the Default Rate;
(3) if payable by a Non-defaulting Party (excluding any period where (1) above applies), the Non-default Rate; and
(4) in all other cases, the Termination Rate.

Applicable Deferral Rate” means:—

(a) For Section 9(h)(i)(3)(A) [payments deferred under Section 2(a)(iii)], the market rate actually offered by a major bank in the interbank market for overnight deposits in that currency that the payer chose in good faith;
(b) For Section 9(h)(i)(3)(B) [payments deferred during a Waiting Period because of an Illegality or Force Majeure] and clause (a)(iii) of Applicable Close-out Rate, the market rate actually offered by a major bank in the interbank market for overnight deposits in that currency that the payer chose in good faith and in consultation with the other party; and
(c) For Section 9(h)(i)(3)(C) [payments not made after a Waiting Period expires while the Illegality or Force Majeure subsists] and clauses (a)(iv), (b)(i)(3) and (b)(ii)(l) of Applicable Close-out Rate, the average of the rate the payer obtains under (a) above and the annual rate of the payee’s cost of funding of that amount.

Automatic Early Termination” is defined in Section 6(a).
Burdened Party” is defined in Section 5(b)(iv).
Change in Tax Law” means the enactment of or amendment to any law (or official interpretation) after the relevant Transaction is executed.
Close-out Amount” means 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, determined as of the Early Termination Date in good faith and in a commercially reasonable manner. The Determining Party may determine Close-out Amounts for groups of Terminated Transactions as long as all Terminated Transactions are accounted for.
Unpaid Amounts and Expenses in respect of Terminated Transactions are excluded from the Close-out Amount calculation.
The Determining Party may consider any of the following (unless it thinks they aren’t available or would produce an unconscionable result):

(i) quotations for replacement transactions that factor in the Determining Party’s creditworthiness and the ISDA terms between the Determining Party and the quoting party;
(ii) third party market data; or
(iii) internal quotes or market data if used by the Determining Party in the regular course to value similar transactions.

Confirmation” is defined in the preamble.
consent” includes things that are functionally like consents.
Contractual Currency” is defined in Section 8(a).
Convention Court” means any court which must apply Article 17 of the 1968 Brussels Convention or Article 17 of the 1988 Lugano Convention.
Credit Event Upon Merger” is defined in Section 5(b).
Credit Support Document” means anything described as such in the Schedule.
Credit Support Provider” is defined in the Schedule.
Cross Default” is defined in Section 5(a)(vi).
Default Rate” means the payee’s self-certified cost of funding plus 1% per annum.
Defaulting Party” is defined in Section 6(a).
A “Designated Event” means that the relevant entity:―

(1) merges with, or transfers substantially all of its assets into, or reorganises itself as another entity;
(2) comes under the effective voting control of another entity; or
(3) makes a substantial change in its capital structure by issuing or guaranteeing debt, equities or analogous interests, or securities convertible into them;

Determining Party” means the party who determines the Close-out Amount.
Early Termination Amount” is defined in Section 6(e).
Early Termination Date” means the date determined under Section 6(a) or 6(b)(iv).
electronic messages” and “electronic messaging systemexcludes e-mails but includes XML documents and similar markup languages.
English law” means the law of England and Wales. “Event of Default” is defined Section 5(a) as modified by the Schedule.
Force Majeure Event” is defined in Section 5(b).
General Business Day” means a day on which commercial banks are open for business.
Illegality” is defined in Section 5(b).
An Indemnifiable Tax is any Tax that is not[133] a Stamp Tax that is not[134] a tax that would not[135] be imposed if there were not[136] a connection between the taxing authority’s jurisdiction and the recipient that did not[137] arise solely from the recipient having performed any part of this Agreement in that jurisdiction.
law” includes any treaty, law, rule or regulation, or tax practice.
Local Business Day” means a General Business Day:

(a) For performing one’s general obligations: where specified in the Confirmation and where any relevant settlement system is operating;
(b) For working out when a Waiting Period expires: Where the Illegality or Force Majeure Event occurs,
(c) For any other payment: Where the account is located and, the principal financial centre for the relevant currency;
(d) For communications: For the recipient (and, for a Change of Account, where the new account will be located); and
(e) For a Default under Specified Transaction: In the relevant locations for performance under the Specified Transaction.

Local Delivery Day” means, for purposes of Sections 5(a)(i) and 5(d), a day on which settlement systems in the relevant location are generally open for business so delivery can be settled by usual market practice.
Master Agreement” is defined in the preamble.
Merger Without Assumption” is defined in Section 5(a)(viii).
Multiple Transaction Payment Netting” is defined in Section 2(c).
Non-affected Party” means the party that isn’t the Affected Party, if there is one.
Non-default Rate” means a rate obtained in good faith by the Non-defaulting Party from a major bank in the interbank market for overnight deposits to reasonably reflect prevailing market conditions.
Non-defaulting Party” is defined in Section 6(a).
Office” means any of a party’s branches or offices.
Other Amounts” is defined in Section 6(f).
Payee” is defined in Section 6(f).
Payer” is defined in Section 6(f).
Potential Event of Default” means an event which, with the giving of notice or the passing of time, would be an Event of Default.
Proceedings” is defined in Section 13(b).
Process Agent” is defined in the Schedule.
Rate of exchange” includes any premiums or exchange costs of buying or converting into the Contractual Currency.
Relevant Jurisdiction” for a party means any jurisdictions (a) where it is incorporated, organised, managed and controlled; (b) where it has an Office through which it acts under this Agreement; (c) where it executes this Agreement; and (d) from or through which it makes payments under this Agreement.
Schedule” is defined in the preamble.
Scheduled Settlement Date” means a due date for payment or delivery under Section 2(a)(i).
Specified Entity” is defined in the Schedule.
Specified Indebtedness” means any borrowed money.
Specified Transaction” means:

(a) any transaction between the parties to this Agreement (or their respective Credit Support Providers or Specified Entities) which is not governed by this Agreement, but
(i) is a swap, option, forward, foreign exchange, cap, floor, collar, credit protection or spread transaction, repo, buy/sell-back, securities lending, index or forward purchase or sale of a security, commodity or other financial instrument;or
(ii) is a similar transaction forward, swap, future, option or other derivative on any rates, currencies, commodities, financial instruments, benchmarks, indices or other measures of economic risk that is at any time common in the financial markets;
(b) any combination of the above; and
(c) any transaction specified as a Specified Transaction in the Schedule or confirmation.

Stamp Tax” means any stamp or documentation tax.
Stamp Tax Jurisdiction” is defined in Section 4(e).
Tax” means any tax of any kind (including interest or penalties added to it) imposed by a taxing authority on any payment under this Agreement other than a Stamp Tax.
Tax Event” is defined in Section 5(b).
Tax Event Upon Merger” is defined in Section 5(b).
Terminated Transactions” means, for a Early Termination Date resulting from:

(a) an Illegality or a Force Majeure Event, all Affected Transactions specified in the Section 6(b)(iv) notice;
(b) any other Termination Event, all Affected Transactions; and
(c) an Event of Default, all Transactions :

that were in effect immediately before the the Section 6(a) notice designating that Early Termination Date took effect or, if Automatic Early Termination applies, immediately before the Early Termination Date.
Termination Currency” means the Termination Currency specified in the Schedule if it is freely available, and failing that euro for English law-governed Agreements or US Dollars for New York law-governed Agreements.
Termination Currency Equivalent” means, for an amount denominated in any other currency, the Termination Currency amount needed to buy that other currency using the FX agent’s spot exchange rate at 11:00 a.m. (in its location) on the day one would customarily fix a rate to purchase that currency for value the relevant termination date.

If there is an Innocent Party, it will select the FX agent in good faith. If not, the parties must agree the FX agent. “Termination Event” means an Illegality, a Force Majeure Event, a Tax Event, a Tax Event Upon Merger an applicable Credit Event Upon Merger or an Additional Termination Event.
Termination Rate” means each party’s self-certified average cost of funding.
Threshold Amount” will be specified in the Schedule.
Transaction” is defined in the Preamble.
Unpaid Amounts” owing to any party means, with respect to a Early Termination Date, the aggregate, in each case as at such Early Termination Date, and together with any the Non-Defaulting Party’s Expenses, of:

(a) in respect of all Terminated Transactions, all amounts that had become payable but which remain unpaid;
(b) in respect of each Terminated Transaction, the fair market value of each obligation which had become due for delivery but has not been delivered; and
(c) where all Transactions are being terminated on the Early Termination Date, any due but unpaid Early Termination Amounts relating to a prior Termination Event,

together in each case with accrued but unpaid interest.
Waiting Period” means:―

(a) for an Illegality (other than where performance under a Credit Support Document is required on the relevant day (here no Waiting Period will apply), three Local Business Days after the Illegality happened; and
(b) for a Force Majeure Event (other than where performance under a Credit Support Document is required on the relevant day (here no Waiting Period will apply), eight Local Business Days after the Illegality happened.

Comparison between versions

Template:M comp disc 2002 ISDA 14

Discussion

Template:M summ 2002 ISDA 14 Template:M gen 2002 ISDA 14 Template:M detail 2002 ISDA 14

Subsection Additional Representation

Comparison between versions

Template:M comp disc 2002 ISDA Additional Representation

Discussion

Template:M summ 2002 ISDA Additional Representation Template:M gen 2002 ISDA Additional Representation Template:M detail 2002 ISDA Additional Representation}}

Subsection Additional Termination Event

Comparison between versions

Template:M comp disc 2002 ISDA Additional Termination Event

Discussion

Template:M summ 2002 ISDA Additional Termination Event Template:M gen 2002 ISDA Additional Termination Event Template:M detail 2002 ISDA Additional Termination Event

Subsection Affected Party

Comparison between versions

Not even ISDA’s crack drafting squadTM could confect something worthwhile to say which might improve this Spartan piece of text. But note the concept of Affected Party is sprayed liberally throughout Section 5(b), and it means something different in almost every context so you’re guaranteed to have fun there.

Elsewhere there is much monkeying around as regards the concept of Illegality, particularly insofar as it relates to Credit Support Documents, and the newly introduced Force Majeure.

Discussion

One who is subject to a Section 5(b) Termination Event, but not a Section 5(a) Event of Default — thus one of a marginally less opprobrious character, seeing as Termination Events are generally not considered to be one’s fault as such, but just sad things that happen that no-one expected, or wanted, but bring what was once a beautiful relationship to an end. It’s not you, it’s — well, it’s not me either — it’s just that confounded tax event that occurred upon your recent merger.

Note that, in its wisdom, ISDA’s crack drafting squadTM chose not to have a generic term for the sort of person who is subject to either a Termination Event or an Event of Default, so there is much “Defaulting Party and/or Affected Party, as the case may be” sort of malarkey. This depresses we prose stylists, but ISDA’s crack drafting squadTM has never cared about us, so we should hardly be surprised.

And given its relentless quest for infinitesimal particularity — and accepting for a moment it is warranted[138] — perhaps ISDA’s crack drafting squadTM has a point, for “Affected Party” appears in subtly different guises in each of the Termination Events. Sometimes there is one Affected Party; sometimes there are two. Where there are two Affected Parties there is not a “victim” and a “perpetrator” as such, but you are in this odd new millennial world where everyone’s a victim, either party may trigger the Termination Event, both may estimate replacement prices on termination and they have to split the difference.

Where there is one Affected Party, only the Unaffected Party can terminate, and it is responsible for obtaining the valuation.

Events of Default vs. Termination Events: Showdown

Puzzled ISDA ingénues[139] may wonder why there are Events of Default and Termination Events under the, er, eye-ess-dee-aye. In any weather, there seem to be rather a lot of them. And there is a third, hidden category: Additional Termination Events that the parties crowbar into the Schedule.

Do we really need all these[140], and what is the difference?

So, with feeling:

Events of Default...

Termination Events ...

In the heyday of ISDA negotiation[145] just who was the Affected Party and how one should value and terminate an Affected Transaction used to be much more of a source of controversy than it is today.

This might be a function of the market’s general move to the 2002 ISDA closeout methodology, being far less fraught and bamboozling then the one in the 1992 ISDA, refraining as it does from absurdities like the First Method and alternative Market and Loss methods of valuing replacement transactions. Even those who insist on staying with the 1992 ISDA — Hello, Cleveland! — are often persuaded to upgrade the closeout methodology.

It might also be that the specific expertise as to what happens in a close out has dissipated over the years as swap dealers and investment managers have outsourced and downskilled their negotiation functions.

But the JC likes to think that in this mature market, the commercial imperative plays a part here. Termination Events come in two types: catastrophic ones, which signal the end of the relationship — and usually the ongoing viability of one of the counterparties — altogether; and Transaction-specific ones, which no-one intended or wanted, everyone regrets, but which will soon be water under the bridge, for parties who will continue to trade new derivatives into glorious, golden perpetuity.

Now any swap dealer who regards a Transaction-specific Termination Event as an opportunity to gouge its counterparty can expect a frosty reception next time its salespeople are pitching new trading axes to the CIO.

On the other hand if, when your valuation reaches her, the CIO is wandering around outside her building with an Iron Mountain box, she will be less bothered about the wantonness of your termination mark — it being no longer her problem — and as far as she does care about it all, will console herself with the reality that you are not likely to see much of that money anyway once her former employer’s insolvency estate has been wound up.

Subsection Affected Transactions

Comparison between versions

The provisions are identical but for reference to the newly added Force Majeure Termination Event and also a cheeky caveat relating to an Illegality or Force Majeure which affects only the Credit Support Document, and here the “leave no detail, however tiresome, unconsidered” department of ISDA’s crack drafting squadTM caters for the eventuality that your Credit Support Document provides credit support for some, but not, all Transactions.

Seeing how third party credit support generally works under an ISDA Master Agreement — it only comes into play once Transactions have been closed out, and there are no Transactions left, Affected or otherwise[146] this does seem a rather fussy detail; all the more so now in the age of regulatory variation margin. I mean, who provides credit support for individual Transactions under a master agreement specifically designed to achieve cross-transactional closeout netting?

Hold your letters: I am sure you can think of some reason.

Discussion

Note that for Additional Termination Events and Credit Event Upon Merger, all Transactions are automatically caught, and if you want to capture just certain Transactions, you’ll need to tweak this definition too.

But why, really, would you want to capture just some Transactions in an ATE? Well, there is a reason, though it is a fussy one:

Additional Representations as Additional Termination Events

In the case of Additional Representations this can be somewhat drastic, especially if your Additional Representation is Transaction-specific (for example India, China and Taiwan investor status reps for equity derivatives), and it would seem churlish to close out a whole ISDA Master Agreement on their account.

Then again, show me a swap dealer who would detonate an entire swap trading relationship with as solvent counterparty and I’ll show you a moron — but, as we know, opposing legal eagles operate on the presumption that everyone else is a moron and thus tend to be immune to such grand rhetorical flourishes, regard such appeals to basic common sense as precisely such flourishes, so don’t expect that argument to carry the day, however practically true it may be.

Instead, expect to encounter leagues of agonising drafting, but there are easier roads to travel. Try:

These representations will be Additional Representations, except that where they prove to be materially incorrect or misleading when made or repeated it will not be an Event of Default but an Additional Termination Event, where the Transactions in question are the Affected Transactions and the misrepresenting party is the sole Affected Party.

Mean time, there is a lot more about how pointlessly over-engineered this clause is at the commentary to Section 6(b)(iv), the Right to Terminate. Template:M gen 2002 ISDA Affected Transactions Template:M detail 2002 ISDA Affected Transactions

Subsection Affiliate

Comparison between versions

The Affiliate definitions are identical between the 1992 ISDA and the 2002 ISDA.

A potentially wide definition which could include, for example, special purpose vehicles whose shareholding is owned by the same corporate service provider, or separate stand-alone hedge funds managed by the same administrator or investment manager.

Discussion

The idea of an “affiliate” is really not a complicated one in the abstract but yet in the world of contracting commercial undertakings it is one which our learned friends rejoice in overdetermining.

For corporate being, an affiliate could be:

  • Parent: its parent or holding company, which holds all or a majority of its ordinary share capital — often abbreviated as a “holdco”
  • Child: its subsidiary — a company the ordinary share capital of which it holds all or a majority
  • Sibling: a company in common ownership with the corporate being; that is to say, a company that shares the same parent or holding company.

No doubt pedants will be anxious to point out that, ordinary shares being the divisible ownership units that they are, and different degrees of control and voting rights attaching to different classes of share, there are degrees of ownership, and some ought to imply more connectedness than others. Fur example, if one owns a small parcel of shares in a listed company does that make it your affiliate? One would like to think not.

In any event the confusion is usually resolved by pointing at the definition of “subsidiary” and “holding company” contained in the Companies Act. The ISDA Master Agreement does a reasonably neat job of capturing the above by reference to the majority of voting control.

Branches and affiliates

Few things are apt to cause more confusion, fear and loathing for less good reason the legal status, as regards itself, of a company’s various branches. This is apt to confuse muggles, which on a busy day can be intensely frustrating for a busy solicitor, but on a slow one is fertile grounds for a little sport at the expense of our non-magical friends. You will be surprised how often one is asked to review, approve or even sign a contract, keep-well agreement or service level agreement between a branch of a company and its head office. The best response is just to sign it, but purists will find this at least aggravating and in many cases a betrayal of the attorney’s sacred oath.

  • Affiliates: By contrast, a company’s affiliate is a related but separate legal entity. If a company is a person, its affiliate is its parent, child, or sibling. Parent affiliates are actually even called parents. Children are wholly-owned subsidiaries, ugly stepchildren and bastards are majority-owned subsidiaries and siblings are known as companies “under common ownership”. There is plenty of scope for ugly sisters, black sheep and long-lost cousins from Australia, as you can imagine. Proper affiliates may be consolidated from a financial reporting perspective, but generally (and unless it has specifically agreed to) an affiliate is not responsible for performing the obligations of its any of its affiliates unless it agrees to do so by contract (such as a guarantee).

Template:M gen 2002 ISDA Affiliate Template:M detail 2002 ISDA Affiliate

Subsection Agreement

Comparison between versions

The “Agreement” is, broadly, the ISDA Master Agreement, the Schedule, any 1995 English Law CSA and, in the context of any Transaction, its Confirmation. It generally would not include a Credit Support Document (except to the extent you treat your 1995 English Law CSA, rightly or wrongly,[147] as a Credit Support Document.

Discussion

The ISDA Master Agreement

The ISDA Master Agreement is the basic framework which applies to anyone who touches down on planet ISDA. There are three existing versions:

  • the state-of-the-art 2002 ISDA;[148]
  • the still-popular-with-traditionalists-and-Americans 1992 ISDA, and
  • the all-but-retired-but-don’t-forget-there-are-still-soldiers-in-the-Burmese-jungle 1987 ISDA[149]
  • the interesting-only-for-its-place-in-the-fossil-record-and-witty-acrostic 1985 ISDA Code; and
  • there isn’t a 2008 ISDA. That’s a little running JC in-joke.[150]

All three versions have a tri-partite form: Pre-printed Master, Schedule and — well, this is controversial: for is it, or is it not, part of the ISDA Master Agreement? — Credit Support Annex.

Pre-printed master

The first part of the trinity is the pre-printed form of ISDA Master Agreement.

  • Content: The ISDA Master Agreement has 14 “Sections” and is inviolate. It doesn’t have much to say about any particular Transaction, but just assumes you will be entering lots of them, and provides for general terms that apply to all of them. So, Representations, covenants to maintain certain standards and supply credit information, and critically Events of Default, Termination Events, and Close-out rights. Close-out is deep ISDA lore: this is what almost all of the excitement in an ISDA negotiation is about, and there will be much more to say about it later.
  • You don’t edit it: You don’t, despite the darkest fears of your internal audit department, ever edit this document. Ever. This is by quite deliberate design. Everyone in the market knows the ISDA intimately, and there is good comfort in knowing, when it comes to that terrible moment when, as the world goes to hell, you have to understand your rights and obligations, that you don't have to read the 19 pages of the pre-print as well. Even the pagination and line-layout is sacrosanct: Some connoisseurs cherish the Schedule amendment which purports to excise “the third word of the second line of limb (b) of Section 5(a)(viii)”. Honestly. The ISDA Master Agreement’s generally a .pdf, so you can’t[151] but, in any weather, you don’t.[152] You just don’t.
  • You do amend it: But, of course, an ISDA Master Agreement is nothing without a long and pointless negotiation to amend, augment or clarify this agreement! And to be sure you can amend an ISDA, but you do this is by providing for an amendment in your ...

ISDA Schedule

This overlays the pre-printed master agreement. Here you specify Additional Termination Events, add economic variables, names, addresses, add Tax Representations and then, in Part 5, you are free to make any technical amendments your credit and legal chicken lickens want for the avoidance of doubt, and that you couldn't make because technical ineptitude and unerring market convention prevented you editing the preprinted master. That comprises your overarching ISDA Master Agreement, though you may also have a ...

Credit support arrangement

The credit support arrangement usually takes the form of an annex to the ISDA Master Agreement. It may be under English law or New York law. The English law CSA has 11 “Paragraphs”; the 1994 New York law CSA — which has fiddly and rather pointless security provisions — has 13, in each case the last one being an editable schedule of Elections and Variables. Like the ISDA Master Agreement you don’t edit the pre-printed Paragraphs. Now in order to document a specific Transaction you will need a...

Confirmation

The Confirmation is the thing that actually documents a specific swap Transaction. This you can edit, to your heart’s content. There is sometimes an intermediate Master Confirmation Agreement which documents the generic terms for all, say equity derivative Transactions. Template:M gen 2002 ISDA Agreement Template:M detail 2002 ISDA Agreement

Subsection Applicable Close-out Rate

Comparison between versions

No equivalent under the 1992 ISDA.

Discussion

Truly from the I’m sorry I asked file — almost in the shoot me file. This whole game of pan-dimensional chess, with six different rates to apply in different circumstances, is all just to work out how to accrue interest on Unpaid Amounts and Early Termination Amounts when closing out. You get a strong sense that the pragmatists of ISDA’s crack drafting squadTM — if there are any — had well and truly tuned out and gone to the bar by the the ’squad got to this definition. Looking on the bright side, at least it doesn’t mention LIBOR.[153]

You have the Default Rate, the Non-default Rate, the Applicable Deferral Rate, and the Termination Rate. Depending on how and why you have closed out the 2002 ISDA, and whether you were at fault, a different rate will apply.

The four rates are:

All sensible enough, if not a little over-determined — and then the threeApplicable Deferral Rates”, which convert this from something that is merely tedious to the stuff of a Hieronymus Bosch nightmare. Template:M gen 2002 ISDA Applicable Close-out Rate Template:M detail 2002 ISDA Applicable Close-out Rate

Subsection Applicable Deferral Rate

Comparison between versions

This is all in the service of calculating interest at close out on payments that have been somehow deferred (under the Section 2(a)(iii)flawed asset” provision, or because of Illegality or Force Majeure). It is, we think, an inordinate amount of verbal engineering to answer an uncontroversial question (viz., “what’s a fair interest rate to charge?”) in a deeply remote contingency.

ISDA’s crack drafting squadTM. Never knowingly unfussedTM.

Discussion

If you want to find out the Applicable Close-out Rate, chances are you will bump into one of these deferred payments rates. Actually there are three Applicable Deferral Rates, depending on why a payment was deferred, and for how long it has been deferred.

(a) If it is a 2(a)(iii) deferral, it is the actual rate the payer — being the one suspending the payment as a result of the other’s failure, of course — obtains in good faith in the inter-bank market.
(b) If it is a deferral during a Force Majeure or Illegality waiting period, it’s that rate, only the payee gets to be consulted with about which bank it is. Yes, I know: — like, wow.
(c) If the Waiting Period has expired but the Illegality or Force Majeure which is preventing the payment subsists, it is the average of the first such rate (that is, the one without consultation, so I suppose the payer can run off to a different bank, even though it consulted with the payee on the bank it used for the Waiting Period), but then it has to average that out against the payee’s cost of funding the amount it hasn’t received as a result of the suspension.

This might make sense as a piece of crystalline intellectual logic — so does an Yngwie Malmsteen guitar solo — but, practically, you have to wonder whether ISDA’s crack drafting squadTM hadn’t been hooking into the brandy a bit before knock-off time. I mean what on Earth were they thinking? Template:M gen 2002 ISDA Applicable Deferral Rate Template:M detail 2002 ISDA Applicable Deferral Rate

Subsection Automatic Early Termination

Comparison between versions

Those with a keen eye will notice that, but for the title, Section 6(a) of the 2002 ISDA is the same as Section 6(a) of the 1992 ISDA and, really, not a million miles away from the svelte form of Section 6(a) in the 1987 ISDA — look on that as the Broadcaster to the 1992’s Telecaster.

Discussion

Automatic Early Termination is an odd and misunderstood concept which exists in Section 6(a) Right to Terminate Following Event of Default of the ISDA Master Agreement. As is so much in the ISDA Master Agreement, it’s all about Netting. Where a jurisdiction suspends terms of contracts in a period of formal insolvency, the idea is to have the ISDA break before that suspension kicks in — so close-out netting works.

AET is thus only triggered by certain events under the Bankruptcy event of default — formal bankruptcy procedures — and not by economic events that tend to indicate insolvency (such as an inability to pay debts as they fall due, technical insolvency or the exercise of security. Nor does it apply to other Events of Default.

AET Generally

Automatic early termination (“AET”) protects in jurisdictions (e.g., Germany and Switzerland) where certain bankruptcy events would allow a liquidator to “cherry-pick” those transactions it wishes to honour (those which are in-the-money to the defaulting party) and avoid those where the defaulting party is out-of-the-money.

It is only really useful to a regulated financial institution which is incurs a capital charge if it doesn't have a netting opinion.

In most other cases the remedy is worse than the disease: it means your master agreement terminates whether you like it or not and whether you know about it or not.

Normally, these are things you would like to control:

  • A termination right is a right, not an obligation. That means you have the option not to terminate: you may well not want to if your contract is significantly out of the money (because it would involve you paying out that negative mark-to-market value.
  • AET happens automatically, and doesn't require you to know about it. This leaves you potentially unhedged for market risk between the automatic termination date and the date you found out about it.This is particularly so in the case of the 2010 GMSLA and 1995 Overseas Securities Lender's Agreement (OSLA), where the close out mechanism is nuanced.

Applying AET against a counterparty in a jurisdiction where it is not needed

Automatic early termination is predominantly useful in jurisdictions which recognise “zero-hour” rules in their insolvency regimes. Only a few jurisdictions recognise those rules (eg Switzerland[154] and Germany) - here AET is potentially useful. Where they are not recognised, AET puts a non-defaulting party in a manifestly worse position than it would otherwise be in: it is deprived of the option not to terminate.[155]

There are two reasons why, historically, a party might want to apply AET to an English company:

  • To avoid the risk of a winding up order being made in respect of the bank where the non-defaulting party was unaware of the event (not a likely scenario in the case of [Counterparty]) and therefore had not terminated the agreement. Where that happens, the determination of the present value of future cashflows follows a formula prescribed in the insolvency regs rather than being determined across the part of the relevant depo curve rate which a trading desk might otherwise apply under section 6, (and obligations are required to be set off as of the date of the winding up order) and
  • historic sensitivity around the availability of set-off rights in respect of contingent debt obligations (such as fully paid options) owed to the defaulting party - the argument being that the exercise of rights under section 6 removes the contingency - this latter concern was relieved by a case before the House of Lords in 2004 and a subsequent change to the Insolvency rules in 2005 so should be redundant.

Beyond that I doubt it is helpful to include. If the ETA falls on a Monday because of the AET but the non defaulting party is not aware of the trigger till Friday, then it could be challenged by as to the timing of the close out and the basis of obtaining prices. That issue was looked at in the High Risk v litigation and was also discussed in the Peregrine v JP Morgan litigation in New York in 2005.

Tedious but harmless drafting tweaks

Even for the Non-Defaulting Party, AET is a necessary evil. It leaves the Non-Defaulting Party at risk of being un-hedged on a portfolio of Transactions that automatically terminated effective as of a Bankruptcy event without the NDP knowing that the Bankruptcy event had happened[156]. The NDP may want to capture the market risk between the Bankruptcy event and the date on which they should have known about it, and factor that into the Close-out Amount. If they do, expect to see language like the below.

If you are an AET counterparty, your credit officer may bridle at the sight of this, but you can reassure her that at any point where this language comes into play she will be wandering around outside in a daze clutching an Iron Mountain box full of gonks, comedy pencils and deal tomb-stones, and contemplating a career reboot as a maths teacher, so she shouldn’t really care anyway.

Adjustment for Automatic Early Termination: If an Early Termination Date occurs following an Automatic Early Termination event, the Early Termination Amount will adjusted to reflect movements in rates or prices between that Early Termination Date and the date on which the Non Defaulting Party should reasonably have become aware of the occurrence of the Automatic Early Termination.

Switzerland

Switzerland is — isn’t it always? — different, and a good place to go right now would be the Swiss bankruptcy language page. Switzerland itself is also a good place to go, especially in the skiing season. The JC loves Wengen.

AET under the 1987 ISDA

Note the somewhat difficult position for AET under the 1987 ISDA - a fuller discussion at that article - which was part of the reason for the move to the 1992 ISDA in the first place. Template:M detail 2002 ISDA Automatic Early Termination

Subsection Burdened Party

Comparison between versions

Template:M comp disc 2002 ISDA Burdened Party

Discussion

Template:M summ 2002 ISDA Burdened Party Template:M gen 2002 ISDA Burdened Party Template:M detail 2002 ISDA Burdened Party

Subsection Change in Tax Law

Comparison between versions

Template:M comp disc 2002 ISDA Change in Tax Law

Discussion

So one mild observation here is that this definition of a “Change in Tax Law” does not specifically mention, you know, tax per se. Which at first glance is odd.

This transpires not to matter, though, seeing as Change in Tax Law appears only twice in the 2002 ISDA, and in each case the context in which it appears is very specific to tax. They are:

The provisions surrounding gross up and termination and Indemnifiable Taxes are some of the most (linguistically) complicated in the ISDA Master Agreement, by the way. Template:M gen 2002 ISDA Change in Tax Law Template:M detail 2002 ISDA Change in Tax Law

Subsection Close-out Amount

Comparison between versions

A comparison between the 1992 ISDA and the 2002 ISDA can be found on the ISDA Comparison page.

On the difference between an “Early Termination Amount” and a “Close-out Amount

The 1992 ISDA features neither an Early Termination Amount or a Close-out Amount, which many would see as a regrettable oversight. The 2002 ISDA has both, which looks like rather an indulgence, until you realise that they do different things.[157]

A Close-out Amount is the termination value for a single Transaction, or a related group of Transactions that a Non-Defaulting Party or Non-Affected Party calculates while closing out an 2002 ISDA, but it is not the final, overall sum due under the ISDA Master Agreement itself. Each of the determined Close-out Amounts summed with the various Unpaid Amounts to arrive at the Early Termination Amount, which is the total net sum due under the ISDA Master Agreement at the conclusion of the close-out process. (See Section 6(e)(i) for more on that).

ISDA’s crack drafting squadTM introduced the Close-out Amount into the 2002 ISDA to correct the total trainwreck of a close-out methodology set out in the 1992 ISDA. In the “good old days”, you valued Terminated Transactions were valued according to Market Quotation or Loss and those un-intuitive and — well, flat-out nutso — “First” and “Second” Methods. There is a “Settlement Amount” concept under the 1992 ISDA, but it only really relates to Market Quotation.

Discussion

From the you’ll be sorry you asked file. Have a butcher’s at the nutshell version on the right. If, having read that, you’re still not really feeling sorry or resentful, the full text (below) right might get your remorse radar pinging.

Note the prominent requirement to achieve a “reasonable” (1992 ISDA) or “commercially reasonable” (2002 ISDA) result. On what that latter lovely expression means see Barclays v Unicredit. Spoiler: it’s basically good for brokers as long as they aren’t being total dicks.

There are some local variations which are worth bearing in mind:

Close-out Amount and Italian counterparties

See for more detail, here: Italian counterparties

Releationship with Early Termination Amount

For those curious about the difference between the Early Termination Amount and the Close-out Amount in the 2002 ISDA, look no further than back there, along the sentence you've just read. Go on.

Closing out an ISDA Master Agreement following an Event of Default

Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.

In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.

So, you will need:

(i) a Failure by the Defaulting Party to make a payment or delivery when due;
(ii) a notice by the Non-Defaulting Party under Section 6(a) to the Defaulting Party that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.
(i) The standard grace periods are set out in Section 5(a)(i). Be careful here: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
(ii) So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
(iii) At the expiry of this grace period, you finally have a fully operational Event of Default. Now Section 6(a) gives you the right, by not more than 20 days’ notice[159] to designate an Early Termination Date for all outstanding Transactions. So, at some point in the next twenty days.
(iv) For this we go to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked. For it not to be (i.e., if Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.

Template:M detail 2002 ISDA Close-out Amount

Subsection Confirmation

Comparison between versions

Template:M comp disc 2002 ISDA Confirmation

Discussion

Template:M summ 2002 ISDA Confirmation Template:M gen 2002 ISDA Confirmation Template:M detail 2002 ISDA Confirmation

Subsection consent

Comparison between versions

Template:M comp disc 2002 ISDA consent

Discussion

Template:M summ 2002 ISDA consent Template:M gen 2002 ISDA consent Template:M detail 2002 ISDA consent

Subsection Contractual Currency

Comparison between versions

Template:M comp disc 2002 ISDA Contractual Currency

Discussion

Template:M summ 2002 ISDA Contractual Currency Template:M gen 2002 ISDA Contractual Currency Template:M detail 2002 ISDA Contractual Currency

Subsection Convention Court

Comparison between versions

Template:M comp disc 2002 ISDA Convention Court

Discussion

The 1968 Brussels Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters is This fellow. Be my guest. Let me know what you find.

The 1988 Lugano Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters is this puppy. Knock yourself out, and let us know how you get on. Template:M gen 2002 ISDA Convention Court Template:M detail 2002 ISDA Convention Court

Subsection Credit Event Upon Merger

Comparison between versions

Template:M comp disc 2002 ISDA Credit Event Upon Merger

Discussion

Template:M summ 2002 ISDA Credit Event Upon Merger Template:M gen 2002 ISDA Credit Event Upon Merger Template:M detail 2002 ISDA Credit Event Upon Merger

Subsection Credit Support Document

Comparison between versions

No changes between the versions of this rather unnecessary definition. The men and women of ISDA’s crack drafting squadTM must have stood back and admired the handiwork of their 1992 forebears, high-fived each other and gone, “nice job, dudes and dudettes”.

Discussion

Being the document by which Credit Support is provided by a Credit Support Provider.

The 1995 English Law CSA is not a Credit Support Document...

Note that a CSA[163] is not a Credit Support Document, and you should not list it as one in Part 4 of the Schedule, however satisfying it might be to do so. I mean it sounds like one, right? But no: the counterparty cannot be its own Credit Support Provider. The 1995 English Law CSA is, rather, a Transaction under the ISDA Master Agreement. This is rather important to the whole issue of close-out netting. Deep ISDA lore.

... but the 1994 New York law CSA is a Credit Support Document

Because it is a security financial collateral arrangement arrangement and not a title transfer collateral arrangement, transfer of credit support under a 1994 New York law CSA[164] does not change the net liabilities between the parties, the 1994 New York law CSA (and its regulatory VM successor, the 2016 NY Law VM CSA is a Credit Support Document and not a transaction under the ISDA Master Agreement. Fun, huh?

Guarantees and the ISDA Master Agreement: why Transaction-specific guarantees don’t work

Should a client request a transaction-specific parental guarantee (or letter of credit) for a Transaction under an ISDA Master Agreement instead of the usual “all obligations” guarantee of all the counterparty’s obligations under the ISDA Master Agreement, hit the alarm button.

You should never agree to the guarantee of individual Transactions (nor accept a letter of credit with respect to individual Transactions) under an ISDA Master Agreement. If you do, because of the way ISDA Master Agreements are closed out under Section 6(e) — or rather, aren't closed out, you might find that just when you want your guarantee to pay, the Transaction it is guaranteeing isn’t there anymore:

On a close-out, each Transaction is terminated, the individual close-out amounts are determined, they’re aggregated up to a single net sum (i.e. negative exposures are netted off against positive ones) and a single Close Out Amount is payable with respect to all terminated Transactions under 6(e) (Payments on Early Termination) of the ISDA Master Agreement.[165]

That is to say, payments following termination of a Transaction are not payable under the Transaction at all - they are payable under the ISDA Master Agreement itself. Therefore, if the guarantee relates to the single Transaction, at the point you wish to rely on it (i.e., upon the party’s default), it will have gone, with no payment required. Vanished, like tears in the rain.
Template:M detail 2002 ISDA Credit Support Document

Subsection Credit Support Provider

Comparison between versions

Template:M comp disc 2002 ISDA Credit Support Provider

Discussion

A 1995 English Law CSA is not a Credit Support Document at all, but a Transaction under the ISDA Master Agreement. A 1994 New York law CSA, on the other hand, is a Credit Support Document though. Should a Party to the ISDA Master Agreement, where there is a 1994 New York law CSA, be described as a “Credit Support Provider"?

No, sayeth the Users' Guide to the 1994 ISDA CSA (NY law):

“Parties to an ISDA Master Agreement should not, however, be identified as Credit Support Providers with respect to the Annex, as such term is intended only to apply to third parties.”

So that’s cleared that up, then. Template:M gen 2002 ISDA Credit Support Provider Template:M detail 2002 ISDA Credit Support Provider

Subsection Cross-Default

Comparison between versions

Template:M comp disc 2002 ISDA Cross-Default

Discussion

Template:M summ 2002 ISDA Cross-Default Template:M gen 2002 ISDA Cross-Default Template:M detail 2002 ISDA Cross-Default

Subsection Defaulting Party

Comparison between versions

Template:M comp disc 2002 ISDA Defaulting Party

Discussion

Template:M summ 2002 ISDA Defaulting Party Template:M gen 2002 ISDA Defaulting Party Template:M detail 2002 ISDA Defaulting Party

Subsection Designated Event

Comparison between versions

Template:M comp disc 2002 ISDA Designated Event

Discussion

Designated Event is part of the definition of Credit Event Upon Merger in the 2002 ISDA, and doesn't have an equivalent in the 1992 ISDA. These are mainly those merger type activities that no-one has ever managed to conveniently label[166] including consolidation, amalgamation, merger, whole-business transfers, reorganisation, reincorporation or reconstitution, or taking control of the company, or changing its capital structure — including creating indebtedness...

Say what?

But issuing indebtedness though?

Question is how significant a debt issuance would it have to be to be a material change in the company’s capital structure?

Some learned commentators feel this is rather harsh, especially if you’re in the finance game, where raising indebtedness is part of what you do. Arguably, a bank deposit is a form of indebtedness. Loosely, so is any negative credit exposure. Likewise, the stricture applies to all Credit Support Providers and Specified Entities, so woe betide if one of those is a financial institution too.

The pragmatist might well say, “yeah, that’s how it reads, but no one would ever take the point right?” While it’s bracing to hear such an expression of trust and confidence in the bona fides of one’s fellow merchant in the markets, just “trusting one other” is not really the vibe of the international derivatives documentation community, and in any case if no one needs this clause, why write it in? All or substantially all is a modifier calculated to snooker that smart Alec who, for example, sells his entire business barring a single chair, to avoid breaching a covenant preventing him from disposing of “all of the business”. This is not the behaviour of a good egg and the better question to ask yourself is why you did business with him in the first place.

In any case, your qualifier leads only to a different kind of uncertainty: what counts as “substantial”? Discussions on the in-any-case tedious topic of Credit Event Upon Merger and Merger Without Assumption tend quickly to go this way. The countless learned articles and client briefing notes on the topic (let me Google that for you) will tell you that the benefit of this kind of drafting accrues mainly to those in the legal profession, but even then only through their very fear and loathing of the notion. Template:M detail 2002 ISDA Designated Event

Subsection Determining Party

Comparison between versions

Template:M comp disc 2002 ISDA Determining Party

Discussion

Not to be confused with a Determining Party for the purposes of the Equity Derivatives definitions, of course. Right?
Template:M gen 2002 ISDA Determining Party Template:M detail 2002 ISDA Determining Party

Subsection Early Termination Amount

Comparison between versions

Template:M comp disc 2002 ISDA Early Termination Amount

Discussion

Template:M summ 2002 ISDA Early Termination Amount Template:M gen 2002 ISDA Early Termination Amount Template:M detail 2002 ISDA Early Termination Amount

Subsection Early Termination Date

Comparison between versions

Template:M comp disc 2002 ISDA Early Termination Date

Discussion

Template:M summ 2002 ISDA Early Termination Date Template:M gen 2002 ISDA Early Termination Date Template:M detail 2002 ISDA Early Termination Date Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter Template:2002 isda book subchapter

Template:2002 isda book subchapter

  1. There is no such thing as a Template:2008ma. That was a joke on our part.
  2. Seriously: proceed with caution with one of these. Template:1987mas don’t have a lot of safety features a modern derivatives counterparty relies on, so only for real specialists and weirdos. Think of it like flying a spitfire rather than a 737 Max. Um, okay, bad Template:T.
  3. Talking to yourself might not be the first sign of madness, but having in-jokes with yourself might be.
  4. I know you can, but you are forgetting about the general technical aptitude of your average ISDA negotiator who can’t figure out how to get goddamn tab stops to work.
  5. “But what if we did?” wails internal audit. How would you know? This is your chance to pull the exasperated Kermit face. It won’t help, of course, but you may feel better.
  6. Yes I know: Section 2(a)(iii). We’ll get to that. And in some jurisdictions mandatory insolvency set-off would also spike an administrator’s guns. But for now, let’s say.
  7. “A chap cannot give away what he doesn’t own in the first place.”
  8. Except under New York law — isn’t that right, rehypothecation freaks?
  9. Amazing in hindsight, really, isn’t it.
  10. This is true in legal theory but in most cases not in practice: usually a swap dealer will offer you a price to close out your trade early — at its side of the market, naturally — and unless you are doing something dim-witted like selling tranched credit protection to broker-dealers under CDO Squareds they have put together themselves, you should be able to find another swap dealer to give you a price on an off-setting trade.
  11. For example, Template:Casenote albeit not related to flawed assets.
  12. You wonder how much of that was influenced by what a bunch of odious jerks Enron were in their derivative trading history, mind you.
  13. Swiss stay too, for that matter.
  14. Other than the representation itself, of course. That would be meta, and actually a bit of a strange loop.
  15. Or whatever. WHATEVER DUDE.
  16. WARNING: CONTRARIAN VIEW COMING UP.
  17. Of course, the Template:Nycsa is a Credit Support Document. Because it just is.
  18. These things are normally called “warranties”.
  19. I am struggling with this, readers, I am. Deemed current, perhaps?
  20. I know, I know.
  21. Unless your credit team decided to define it as such, of course. It does happen.
  22. Judgment day, in other words.
  23. Or whatever. WHATEVER DUDE.
  24. WARNING: CONTRARIAN VIEW COMING UP.
  25. Sigh. Sending.
  26. Sigh. Sending.
  27. Sigh. Sending.
  28. The sorts of people who are interested in learning about sw-æps under an eye-ess-dee-aye. Come on, you were one once.
  29. Controversial view: No, except to protect the livelihoods of an entire cottage industry of sheeple.
  30. You will never guess who.
  31. Please write to me, at youwerewrongyoudolt@jollycontrarian.com, if you ever encounter a close-out — a real, actually-gone-through-with-it, Section 6, whole-ISDA close out based purely on an Additional Termination Event (or, actually, any event other than a Failure to Pay or Deliver or a Bankruptcy) You will be my Black Swan.
  32. I mean the Defaulting Party.
  33. Though this won’t stop excitable credit officers seeking to add that obligation in the negotiation.
  34. The sorts of people who are interested in learning about sw-æps under an eye-ess-dee-aye. Come on, you were one once.
  35. Controversial view: No, except to protect the livelihoods of an entire cottage industry of sheeple.
  36. You will never guess who.
  37. Please write to me, at youwerewrongyoudolt@jollycontrarian.com, if you ever encounter a close-out — a real, actually-gone-through-with-it, Section 6, whole-ISDA close out based purely on an Additional Termination Event (or, actually, any event other than a Failure to Pay or Deliver or a Bankruptcy) You will be my Black Swan.
  38. I mean the Defaulting Party.
  39. Though this won’t stop excitable credit officers seeking to add that obligation in the negotiation.
  40. Spod’s note: This notice requirement is key from a cross default perspective (if you have been indelicate enough to widen the scope of your cross default to include derivatives, that is): if you don’t have it, any failure to pay under your Template:Isdama, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close their Template:Isdama with your Defaulting Party because of it defaulted to you, even though (a) the Defaulting Party hasn’t defaulted to them, and (b) you have decided not to take any action against the Defaulting Party yourself.
  41. See discussion on at Section 6(a) about the silliness of that time limit.
  42. Or their equivalents under the Template:1992ma, of course.
  43. See previous footnote.
  44. Or, in the Template:1992ma’s estimable prose, “the amount, if any, payable in respect of an Template:Isdaprov and determined pursuant to this Section”.
  45. Swiss stay too, for that matter.
  46. Other than the representation itself, of course. That would be meta, and actually a bit of a strange loop.
  47. Yes; the whys and wherefores of ostensible authority are an endless delight; but we can at least say the risk is increased.
  48. I know these sound like borrowing transactions, but they’re fully collateralised, and in fact aren’t.
  49. And — sigh — their Template:Isdaprovs and Template:Isdaprov.
  50. Or — sigh — its Template:Isdaprov or Template:Isdaprov
  51. This is typically wide, though it excludes borrowed money — but check the Agreement!
  52. Except where that happens on maturity: see drafting point below.
  53. I should say I am grateful to my correspondent Nick for his helpful suggestion here. I don’t get many correspondents so it is extra special when one writes in with actual useful feedback. Thanks Nick! (To my other correspondents: hi, nice to hear from you too, but no I have not been in a car accident recently.)
  54. And, to be candid, rightful.
  55. Template:Casenote
  56. That is to say, it is practically useless.
  57. Ahhh, sometimes literally.
  58. By the way, the JC’s personal view is that one should not widen the definition beyond the normal conception of “borrowed money”, and if one is a bank, may wish to narrow it, to exclude deposits See the article on Cross Default under the Template:Isdama for more information.
  59. And, to be candid, rightful.
  60. “meaningful” is in the eye of the beholder, you understand.
  61. This, by the way, is an ISDA In-joke. In fact, Template:Isdaprov is pretty much pointless, a fact that every ISDA lawyer and credit officer knows, but none will admit on the record.
  62. The sorts of people who are interested in learning about sw-æps under an eye-ess-dee-aye. Come on, you were one once.
  63. Controversial view: No, except to protect the livelihoods of an entire cottage industry of sheeple.
  64. You will never guess who.
  65. Please write to me, at youwerewrongyoudolt@jollycontrarian.com, if you ever encounter a close-out — a real, actually-gone-through-with-it, Section 6, whole-ISDA close out based purely on an Additional Termination Event (or, actually, any event other than a Failure to Pay or Deliver or a Bankruptcy) You will be my Black Swan.
  66. I mean the Defaulting Party.
  67. Though this won’t stop excitable credit officers seeking to add that obligation in the negotiation.
  68. We really need not.
  69. Not always precisely, of course: thanks to Mr. Woodford for reminding us all that a manager handling redemptions will tend to nix liquid positions first.
  70. Assuming you have under-cooked your IM calculations in the first place, that is. IM is designed to tide you over between payment periods after all.
  71. It ought to go without saying that the Jolly Contrarian does not condone corporal punishment to wanton boys, although it never did him any harm.
  72. Spod’s note: This notice requirement is key from a cross default perspective (if you have been indelicate enough to widen the scope of your cross default to include derivatives, that is): if you don’t have it, any failure to pay under your Template:Isdama, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close their Template:Isdama with your Defaulting Party because of it defaulted to you, even though (a) the Defaulting Party hasn’t defaulted to them, and (b) you have decided not to take any action against the Defaulting Party yourself.
  73. See discussion on at Section 6(a) about the silliness of that time limit.
  74. Or their equivalents under the Template:1992ma, of course.
  75. See previous footnote.
  76. Or, in the Template:1992ma’s estimable prose, “the amount, if any, payable in respect of an Template:Isdaprov and determined pursuant to this Section”.
  77. I know, I know — or women, but that spoils the Game of Thrones reference, you know?
  78. See footnote 1 and/or get a life.
  79. And we have done our due diligence, you know: in coming to this conclusion the JC has consulted Magic circle law firm partners, managing directors, inhouse GCs and even a former general counsel of ISDA, all of whom swore me to secrecy but were as nonplussed as, let’s face it, you are about this baffling clause.
  80. Hence, a Template:Isdaprov clause in the Template:Isdama. Well — can you think of another reason for it?
  81. Template:Hawf
  82. Such as the sort you could have if it were 1987 and the credit support annex hadn't been invented.
  83. But are there such things in this day and age? Serious question.
  84. A correspondent writes pointing out — quite correctly — that, once an Template:Isdaprov has happened, the option to send a Template:Isdaprov Notice is American. So it is — thanks to Section Template:Isdaprov, a potentially open ended one — until you convert it into something like a European option by sending the notice and specifying a date in the future on which it takes place.
  85. The silly FT book is right about this, to be fair.
  86. “The chances of anything coming from Mars were a million-to-one,” he said. Yet, still they came.
  87. That is, the counterparty to the person whose Template:Isdaprov is suddenly illegal.
  88. That’s “Tax Event Upon Merger” to the cool kids.
  89. That’s “Credit Event Upon Merger” to the cool kids.
  90. Spod’s note: This notice requirement is key from a cross default perspective (if you have been indelicate enough to widen the scope of your cross default to include derivatives, that is): if you don’t have it, any failure to pay under your Template:Isdama, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close their Template:Isdama with your Defaulting Party because of it defaulted to you, even though (a) the Defaulting Party hasn’t defaulted to them, and (b) you have decided not to take any action against the Defaulting Party yourself.
  91. See discussion on at Section 6(a) about the silliness of that time limit.
  92. Or their equivalents under the Template:1992ma, of course.
  93. See previous footnote.
  94. Or, in the Template:1992ma’s estimable prose, “the amount, if any, payable in respect of an Template:Isdaprov and determined pursuant to this Section”.
  95. Or, in fairness, are forced to by some other pedant further up their chain, or a general institutional disposition towards pedantry.
  96. Three days in the Template:1992ma versus one in the Template:2002ma.
  97. Thirty days in the Template:1992ma versus 15 in the Template:2002ma.
  98. Apologies if we are underestimating your faculties here by the way. But if you are clairvoyant, why did you trade with this counterparty in the first place? Huh?
  99. Or un-labelled equivalent for Template:1992mas.
  100. This is not to say it isn’t hugely over-engineered, all the same: regular readers will know that the JC would never not say that about the output of Template:Icds.
  101. Spod’s note: This notice requirement is key from a cross default perspective (if you have been indelicate enough to widen the scope of your cross default to include derivatives, that is): if you don’t have it, any failure to pay under your Template:Isdama, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close their Template:Isdama with your Defaulting Party because of it defaulted to you, even though (a) the Defaulting Party hasn’t defaulted to them, and (b) you have decided not to take any action against the Defaulting Party yourself.
  102. See discussion on at Section 6(a) about the silliness of that time limit.
  103. Or their equivalents under the Template:1992ma, of course.