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An amendment to section 2(a)(iii) of the International Swaps and Derivatives Association (ISDA) Master Agreement has been published which can be used to add a time limit to be able to withhold payments or deliveries in cases of default. Guy Usher, partner in the derivatives group at Fieldfisher, looks at what the amendment will mean in practice.
Press Release: Amendment to the ISDA Master Agreement for use in relation to Section 2(a)(iii) and explanatory memorandum.
Market participants can use the form of amendment agreement to amend their ISDA Master Agreements to insert a time limit on the operation of section 2(a)(iii) in circumstances where an event of a default has occurred in respect of one of the parties. The amendment agreement can be used with either the 1992 ISDA Master Agreement (Multicurrency—Cross Border) or the ISDA 2002 Master Agreement.
There is a long background to the publication of the ISDA amendment to section 2(a)(iii) of the ISDA Master Agreement (1992 and 2002 versions). The issue which the wording now addresses was first highlighted in the Australian case of Enron v TXU in 2003. Following that case there were views expressed that section 2(a)(iii) might amount to a ‘walk-away’ provision for the purposes of the Basel Capital Accords. That issue was referred by the Bank of England to the Financial Markets Law Commission in 2004/5. The New York Fed also participated in the debate but the issue was never concluded. Various other issues on the effect of section 2(a)(iii) arose in a series of English court cases arising out of the collapse of the freight derivatives market. Following the collapse of Lehman Brothers, in December 2009, the UK Treasury published a recommendation that the industry should address the point that section 2(a)(iii) could be used to withhold payments and deliveries indefinitely in certain situations. ISDA subsequently convened a working group to look at this and the other issues which had arisen with section 2(a)(iii) from the freight cases. A first consultation paper was published by ISDA in early 2011 and revised wording was published early in 2014. In fact the other issues regarding the effect of section 2(a)(iii) had in the meantime been resolved by the English Court of Appeal so it now only deals with the concern raised by the UK Treasury.
Section 2(a)(iii) enables a party to stop making payments and deliveries to the other party if the other party is in default or is subject to a potential event of default. The effect of the amendment means that a party may be forced to recommence its payments and deliveries if, being entitled to do so, it has not closed-out the defaulting party after an agreed waiting period has elapsed.
Participants who are concerned that section 2(a)(iii) could be used to their detriment are likely to want to introduce the amendment and in their minds probably to protect themselves in pre-, rather than post-, bankruptcy events. That view arguably reflects a lack of trust between some participants following the financial crisis. A number of buy-side firms have been waiting for the final wording for some time and are perhaps likely to request it first. However, we think there is unlikely to be much impetus for most participants to make this change in the absence of other reasons, at least on a bilateral basis. Market participants are therefore most likely to start to use the amendment on new ISDA Master Agreement negotiations and on up-dates of existing documentation for other reasons. It remains to be seen if a protocol will be published in order to achieve a wider up-take.
There are very few drafting considerations. The only point which ought to require negotiation is the length of the waiting period, which could be anything from 30 to 90 days. We would not anticipate participants wishing to change the rest of the wording. There may, however, be a bigger discussion to be had about whether the same principle should be applied to the similar conditions which exist in the security interest-based ISDA Credit Support documentation.
Interviewed by Anne Bruce.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
First published on LexisPSL Banking & Finance. Click here for a free trial.
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Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.
Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.
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