“Mini Close-Out”

It has long been recognised that a party may have problems delivering a security if another market participant further down the chain fails to deliver.  This can be a particular problem in a market where there is a “short squeeze” (in other words, where there is a lack of availability of the security in general).  The “mini close-out” provisions of the GMRA are an attempt to address this risk – by allowing the parties to choose whether to terminate just the affected transactions, rather than bring their entire relationship to an end.

The first important thing to note about the ‘mini close-out’ provision of the 2011 GMRA is that the parties must elect if they want to treat Paragraph 10(h) (which deals with failures to deliver collateral when the loan is advanced) or Paragraph 10(i) (which deals with failures to ‘return’ collateral when the loan is repaid) as an Event of Default.  They do this by specifying in Annex I to the GMRA that “Paragraph 10(a)(ii) shall apply”.  Note, however, that even if the parties DO NOT want to treat Paragraph 10(a)(ii) as an Event of Default, they will still be able to rely on the provisions of Paragraph 10(h) and Paragraph 10(i), discussed below.

Paragraph 10(h)

Paragraph 10(h) of the 2011 GMRA describes the Buyer’s rights in the event that the Seller fails to deliver “Purchased Securities” to it on the applicable “Purchase Date” (in other words, if the ‘borrower’ fails to provide ‘collateral’ for the ‘loan’ that has been provided by the ‘lender’ at the outset of the transaction).  In these circumstances, the Buyer can do the following:

1. Firstly, require the immediate repayment of the Purchase Price (if it has been paid) (i.e. require repayment of the ‘loan’); and/or
2. Secondly, if the Buyer has “Transaction Exposure”, require the Seller to pay Cash Margin to it in a sufficient amount to extinguish that exposure (in other words, if the ‘amount of the loan plus accrued interest’ is MORE than the amount of collateral taken as security for that ‘loan’ then the lender can require the borrower to pay cash over to redress that imbalance); and/or
3. Thirdly, at any time that the breach is continuing, terminate the transaction by giving notice to the Seller.  In these circumstances, the Buyer will pay to the Seller an amount equal to Repurchase Price – Purchase Price (calculated as at the date of Termination).  In other words, the ‘borrower’ must pay any accrued interest over to the ‘lender’.

Paragraph 10(i)

Paragraph 10(i) of the 2011 GMRA describes the Seller’s rights in the event that the Buyer fails to deliver Equivalent Securities on the Repurchase Date (i.e. if the lender fails to hand back the collateral at the end of the trade).  In these circumstances, the Seller can do the following:

1. Firstly, if it has paid the “Repurchase Price” (so if it has repaid the ‘loan plus interest’) require the Buyer to immediately repay that amount;
2. Secondly, if it has Transaction Exposure, it can require the Buyer to pay Cash Margin to it in a sufficient amount to extinguish that exposure (in other words, if the then market value of the securities it has posted as collateral is MORE than the ‘amount of the loan plus accrued interest’, it can request a balancing payment);
3. Thirdly, at any time that the breach is continuing, terminate the transaction in question (but only that transaction).

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