The “Cash Equivalent Amount” is a concept that is found in Paragraph 4(h) of the 2011 GMRA. Implicitly, Paragraph 4(h) recognises the possibility that a party to a Repurchase Transaction may not be able to deliver securities to its counterparty due to the occurrence of a “short squeeze”.
A “short squeeze” can occur when demand for a particular security outstrips supply. In these circumstances, the price of the security can rise rapidly and it can be very hard to acquire in the market.
Often, “short squeezes” occur in stocks with a small number of traded shares and a small market capitalisation. However, they can involve large, highly traded, stocks as well. For example, in October 2008, a short squeeze temporarily drove the shares of Volkswagen on the Xetra DAX (the German stock market) from EUR 210.85 to over EUR 1,000 in less than two days, briefly making it the most valuable company in the world.
Sometimes, “short squeezes” can occur in relation to securities that have been ‘sold short’. When short sellers move to cover their positions, they will need to purchase the security itself – which in turn drives the price up.
The point to take away is that circumstances can arise in practice which are beyond the control of either party to a Repurchase Transaction and which make it very difficult for a party to return securities of a particular issue. Nonetheless, the party which is unable to deliver the relevant securities is obliged under the GMRA to take some action to protect its counterparty. This is where the payment of a “Cash Equivalent Amount” becomes relevant.
Paragraph 4(h) of the GMRA states that where a party (who is called the “Transferor”) is required to transfer “Equivalent Margin Securities” but is unable to do so (after having used all reasonable efforts to do so) then:
- That party must immediately pay to its counterparty Cash Margin equal to the value of the Equivalent Margin Securities that were not delivered (this cash payment will not bear interest); and
- If the failure to deliver Equivalent Margin Securities is still continuing for two Business Days or more, then the counterparty can require the Transferor to pay an amount in cash equal to the “Default Market Value” of the Equivalent Margin Securities. This amount is known as the “Cash Equivalent Amount”.
A failure to pay a “Cash Equivalent Amount” constitutes an Event of Default under Paragraph 10(a)(iv) of the 2011 GMRA.
“Cash Equivalent Amounts” are factored into close-out calculations under the GMRA.Contact Us