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ISDA Master Agreement:  Amendments to Section 2(a)(iii) Finalised

On 19 June 2014 ISDA published its long-awaited amendment to Section 2(a)(iii) of the ISDA Master Agreement.  The amendment allows market participants to insert a time limit on the operation of Section 2(a)(iii) in circumstances where an Event of Default has occurred in relation to one of the parties, as detailed below.

If an Event of Default has occurred the Defaulting Party may, by serving a notice on the Non-defaulting Party, invoke a 90-day hard stop[1] on the automatic suspension of the Non-defaulting Party’s obligations pursuant to section 2(a)(iii).  As such, at the end of the 90-day period, the Non-defaulting Party must once again make payment/delivery, together with any interest/compensation payment that is due.  This addresses the problems experienced during the financial crisis of Non-defaulting Parties simply choosing to sit on their hands rather than crystallise a loss with a Defaulting Party.

If a Potential Event of Default has occurred the Defaulting Party, by serving a notice on the Non-defaulting Party, can effectively convert that Potential Event of default into an (actual) Event of Default.  The Defaulting Party can then invoke the 90-day hard stop on section 2(a)(iii) which applies to Events of Default.

If a different Event of Default subsequently occurs, then any ‘ticking’ hard stop with respect to an earlier Event of Default will cease to apply (in order to ensure that the Non-defaulting Party has the full benefit of Section 2(a)(iii)(1)).  This is unless that earlier Event of Default related to Bankruptcy under Section 5(a)(vii) – in which case the original hard stop ‘clock’ continues to tick – something which is considered fair to the Non-defaulting Party since Bankruptcy Events of Default are rarely cured.  Of course, the Defaulting Party retains the right to invoke a new hard stop with respect to the more recent Event of Default.  It can also reissue the hard stop notice with respect to the earlier Event of Default.

The 90-day period which defines the length of the hard stop is actually in square brackets, and so may be up for negotiation between parties.  However, ISDA warns those that might look to agree a different time period that the FCA has indicated that it regards a 90-day period as the maximum acceptable time limit and expects this time limit to apply generally.

The Guidance Note accompanying the amendment agreement notes that both the 1994 New York law CSA and the 1995 English law Credit Support Deed[2] (but not the 1995 English law CSA) include a condition precedent similar to that in Section (2)(a)(iii)(1) of the ISDA Master Agreement, protecting a non-defaulting party from having to transfer collateral to a defaulting counterparty.  Market participants are encouraged to consider whether to amend these clauses to provide that they also cease to have effect on the occurrence of a Condition End Date under the relevant ISDA Master Agreement.

In the past, HM Treasury has said that it will legislate if it feels that this issue has not been adequately addressed by the industry.  Now that the final documentation has been published, the regulator’s clock has begun to tick.  Despite the fact that there is no ISDA protocol in sight which could help with the process of amending existing documentation portfolios, a timely and robust response is expected.  On the basis that it is ‘better the devil you know than the devil you don’t’, firms should, in the very near future, confirm their internal position on all elements of the amendment and begin the client outreach process necessary to implement these changes in full.



[1] See the definition of “Condition End Date”

[2] See Paragraph 4(a)(i)

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