Tips to Negotiating an ISDA® Agreement
The ISDA® Agreement is comprised of 2 parts: the master terms (boiler plate legal provisions) and the schedule (elections and optional provisions, credit and jurisdictional provisions). The ISDA® can therefore be ‘tailor-made’ to suit the counterparty and the particular credit risks or jurisdictional requirements of the counterparty by negotiating terms into the schedule.
The main credit provisions to consider in the negotiation of an ISDA® are as follows:
1. Specified Entity: These elective provisions allow the parties to extend certain events of default and termination events to other affiliates in the ISDA® counterparty’s group structure, so that a termination can be triggered under the ISDA® in the event that the listed affiliate (or Specified Entity) triggers the listed event of default or termination event. This clause would be useful if the entity signing the ISDA® is not the major asset-holding entity in the group structure.
2. Cross Default: This clause is triggered where a party fails to pay a borrowed money obligation (defined in the agreement as Specified Indebtedness) when due, after the expiry of the grace period, provided that the amount which fails, exceeds the stipulated threshold amount. Parties to the ISDA® often amend this standard provision by extending the grace period to cure a failure to pay on a borrowed money obligation to three business days. The standard grace period to rectify a failure to pay under the ISDA® is one business day. Given that a failure to pay event of default does not trigger automatically, but requires a default notice to be served (and therefore a decision to be made by the non-defaulting party that they wish to accelerate the obligation); and given that the standard grace period for a failure to pay is one business day – it is questionable as to why a party would want to extend this grace period. By including such a provision in an ISDA® Schedule, one is contractually agreeing to delay the ability to terminate and close out transactions. In a volatile market, it could mean that the non-defaulting party is delayed in calculating the value of transactions that they wish to terminate. If one adheres to the standard clause, there would be provision for one business day’s grace to rectify the failure to pay obligation, but after that the non-defaulting party could decide whether the failure constituted a serious enough credit concern to warrant the triggering of the cross default clause.
3. Additional Termination Events: This part of the schedule enables parties to consider any other credit concerns which they may have, and include other triggers, which could lead to rights of termination being invoked. Some of these clauses may be as follows:
A Credit Downgrade Clause: Perhaps the parties have a policy that transactions may not be entered into with below investment-grade firms. In this instance, it may be beneficial to include a termination trigger, which can be invoked if a counterparty suffers a ratings downgrade below investment grade.
Incorporation of Financial Covenants by Reference: If the parties have a loan agreement in place, they may wish to incorporate some credit terms and financial covenants from the loan agreement into the ISDA®.
Change of Ownership/Control: If your counterparty is not the entity with whom the main credit relationship is with, it may be important from a credit point of view to ensure that the entity with whom you are contracting, continues to be owned or controlled by the entity where you have the credit relationship.
4. Calculation Agent provision: The ISDA® Agreement requires the parties to stipulate which party will act in the capacity of a calculation agent (calculating the settlement amount for transactions, among other things). This is usually the bank or financial entity. The ISDA® does not however give dispute rights to the other party. Therefore it is often pertinent to draft dispute rights into the schedule to the agreement, to ensure that the other party has contractual rights to dispute a calculation or valuation. This is of heightened importance in the equity and credit derivative environment where the calculation agent plays a more enhanced role (determining whether a credit events has happened, for example).
5. Negative Consent clauses: Some parties like to include provisions in the ISDA® Schedule, which set out the procedure for sending confirmations for transactions. Sometimes the party who sends the confirmation does not wish to be subject to a very long delay in getting the signed confirmation back from the other party, and as a result, will include wording that stipulates that if a confirmation is not signed and returned within a certain timeframe, it will be deemed to be an accepted confirmation. This could be problematic, as it effectively throws out any right to correct a term or dispute the terms of a confirmation, if the dispute is not raised within the defined time period. Although this type of clause may be redundant when using a trade matching system (like Markitwire or TriOptima, where confirmations are not exchanged per se), it would be important to ensure you check the clause and guard against negative consent where manual confirmations are being exchanged.
DeriviDoc offers consulting and negotiation services to assist you in negotiating your ISDA® Agreements. We also offer courses on the ISDA® Master Agreement which offer insight in to the terms of the ISDA® Agreement (from an operational, credit and legal perspective). Our next course will be in early 2017.
Contact us for further information.