This part of the Guide provides guidance on the termination provisions, particularly:
- Part 1(a) - "Specified Entity";
- Part 1(b) - "Specified Transaction";
- Part 1(c) - "Cross default";
- Part 1(d) - "Credit Event Upon Merger";
- Part 1(e) - "Automatic Early Termination";
- Part 1(f) - "Termination Currency"; and
- Part 1(g) - "Additional Termination Events".
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Part 1(a) - "Specified Entity"
It is necessary to specify the "Specified Entity" for the purposes of various sections of the agreement in relation to both Party A and Party B. The term "Specified Entity" is used in relation to the following terms:
- Default Under Specified Transaction;
- Cross Default;
- Bankruptcy; and
- Credit Event Upon Merger.
Users must specify in the Schedule the meaning of Specified Entity for each term (if applicable).
Section 5(a)(v). This is the event of default dealing with defaults under "Specified Transactions". Under the definition of Specified Transactions, if no Specified Entities are specified in Part 1 of the Schedule, this Event of Default relates only to transactions between the actual parties to the ISDA Master Agreement. If a party deals with other entities in the same group as the counterparty, they may choose to specify them as Specified Entities for the purpose of this item in the Schedule. If there are no Specified Entities, insert "nil".
Section 5(a)(vi). This deals with cross default. Again, as for the previous item participants need to determine whether the cross default provisions are to apply to other entities. If not, insert "nil".
A cross default clause gives a party the right to terminate if the other party defaults under an agreement with another entity. In a cross default clause it is always necessary to identify:
- the type of other agreement which is the subject of the clause;
- a minimum amount which can become owing under the other agreement before cross default is triggered.
Therefore Section 5(a)(vi) is linked with Part 1(c) of the Schedule where "Specified Indebtedness" and "Threshold Amount" must be defined if cross default is to apply.
Section 5(a)(vii). This is the event of default dealing with bankruptcy of the relevant party or any applicable Specified Entity. Again, it is necessary to determine whether the bankruptcy of any party other than the counterparty named in the ISDA Master Agreement should constitute an event of default. An obvious example of a Specified Entity which it may be appropriate to specify would be the parent of the entity which enters into the ISDA Master Agreement. Guarantors normally would be specified as Credit Support Providers at part 4(g) of the Schedule (see 2.1.4.50 "Credit Support Providers").
Section 5(b)(v). This is the Termination Event dealing with Credit Event Upon Merger. The concept of "Credit Event Upon Merger" is triggered following a "Designated Event". Designated Events include mergers, changes in control and capital restructures. Again, it is necessary to consider whether any entities need to be specified for this purpose.
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Part 1(b) - "Specified Transaction"
The definition of "Specified Transaction" in Section 14 extends across all transactions which might be the subject of the ISDA Master Agreement Generally, it is recommended that the Section 14 definition be used.
However, an alternative definition can be set out at this point.
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Part 1(c) - Cross default
It is necessary to determine whether the cross default provisions of Section 5(a)(vi) will or will not apply to each party.
Specified Indebtedness
The definition of "Specified Indebtedness" in Section 14 is limited to any obligation in respect of "borrowed money".
An option available to participants is to extend the definition of Specified Indebtedness to refer to other types of obligations (eg to obligations under finance leases, derivatives transactions and letters of credit). It is emphasised that the definition set out below is not mandatory and whether it is used is a matter for parties to negotiate.
To extend the meaning, some Australian participants use the following wording in Part 1(c) of the Schedule to an ISDA Master Agreement:
"Specified Indebtedness" means any obligation (whether present or future, contingent or otherwise, as principal or surety or otherwise) in respect of money borrowed or raised or under any finance lease, redeemable preference share, letter of credit, futures contract, guarantee, indemnity or a transaction of a type described in sub-paragraphs (a)(i) and (ii), (b) and (c) of the definition of Specified Transaction.
The definition can be extended to cover other categories of transactions too. In some circumstances the type of transaction giving rise to indebtedness will be irrelevant and what will be of more significance is the amount of that indebtedness for the purposes of Section 5(a)(vi) (the Threshold Amount). In other circumstances the type of indebtedness might be relevant. Depending on their particular situation, a party with a large number of trade creditors might not consider it appropriate for defaults in payment of their trade debts to trigger a default under their Transactions.
The phrase "a transaction of a type described in sub-paragraphs (a)(i) and (ii), (b) and (c) of the definition of Specified Transaction" is intended to include the full range of transactions listed in that definition which are traded in the financial markets but obviously not limit the transactions to those entered into between parties named in the definition of Specified Transaction. This approach was adopted because it is the most complete list of types of transactions which could be identified and which could be cross-referred to simply.
The issue of whether to change the definition of Specified Indebtedness essentially is a credit issue. It is a matter for each counterparty to decide whether it is agreeable to extend the definition in the manner suggested above.
Threshold Amount
It is necessary to insert an amount as the "Threshold Amount". This is the minimum aggregate amount in respect of which there must be a "cross default" before the cross default clause can be triggered. This is relevant for Section 5(a)(vi) (the cross default clause). It is open to the parties to agree which currency will be specified for the purpose of nominating the Threshold Amount. Consider adding after the amount specified "or its equivalent in another currency or currencies".
If the Threshold Amount is to be expressed as a percentage of shareholders' equity, Part 1(c) of the Schedule to an ISDA Master Agreement could be completed as follows:
"Threshold Amount" means in relation to Party [ ], [ ]% of the total shareholders' equity of Party [ ] as specified from time to time in the most recently published audited accounts of Party [ ]."
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Part 1(d) - Credit Event Upon Merger
It is suggested that generally the "Credit Event Upon Merger" provisions of Section 5(b)(v) should be expressed to apply to both Party A and Party B. However, Section 5(b)(v) should be reviewed and participants should be satisfied in each instance that it is relevant and appropriate.
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Part 1(e) - Automatic Early Termination
This item allows parties to specify whether or not Automatic Early Termination is to apply. In 2.1.3.20 "Automatic Early Termination" we recommend that Automatic Early Termination should not apply. Accordingly, it is recommended that "will/" should be deleted.
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Part 1(f) - Termination Currency
It is necessary to specify a "Termination Currency". Termination Currency is the benchmark for determining the amount payable on early termination.
In Australia, it is customary to specify Australian dollars as the Termination Currency. If Australian Dollars are not selected as the Termination Currency and the Defaulting Party is an Australian corporation which is wound up, s 554C of the Corporations Act could become relevant. S 554C deals with claims admissible to proof which are denominated in a foreign currency. For the purpose of proving the debt, the debt must be converted into Australian dollars as at the date of the commencement of the winding up. Therefore, if the Section 6(e) amount is determined in non-A$, it would be subject to being converted, for the purpose of proving the debt, in accordance with s.554C. However, it is considered that this possibility can be avoided if the Termination Currency is A$. This is because s.554C is limited to converting debts for the purpose of proof. It is not considered that it should affect contractual rights (such as under Section 6(e)) for determining the amount of the debt.
Accordingly, it is suggested that this item be completed by inserting:
""Termination Currency" means Australian dollars."
The application of s.554C to the Payment Systems and Netting Act is discussed further in [2.23] of 4.3.3 "Netting".
If one of the parties is not an Australian corporation, there may be some benefit in providing flexibility to determine the Termination Currency bearing in mind the possibility that the jurisdiction of a foreign counterparty may have legislation similar to s 554C of the Corporations Act. The recommended wording to insert in Part 1(g) of the Schedule to an ISDA Master Agreement is as follows:
""Termination Currency" means the currency selected by the non-Defaulting Party or the non-Affected Party, as the case may be or, if there are two Affected Parties, the currency agreed between Party A and Party B. If Party A and Party B cannot agree upon a currency, the currency will be Australian dollars."
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Part 1(g) - Additional Termination Event
This item allows participants to set out the wording of an Additional Termination Event. See Sections 5(b)(vi) and 6(b)(iv) of the ISDA Master Agreement.
An Additional Termination Event may be included in respect of an issue concerning Section 2(a)(iii) of the ISDA Master Agreement (commonly referred to as the "flawed asset" provision). There are now two approaches set out in the Guide to deal with this issue. These approaches and commentary are set out in 2.1.4.70.9 "Amended Condition Precedent or Additional Termination Event".
Credit rating downgrading
Some market participants desire the ability to terminate Transactions if their counterparty falls below a designated credit rating as published by one of the major credit rating agencies. Including this ability into an ISDA Master Agreement is optional. It is emphasised that the clause set out below is not mandatory and it would be inappropriate for one party to insist to another that it is mandatory.
Usually, participants agree that this should be treated as a Termination Event rather than an Event of Default.
Under the ISDA Master Agreement a credit rating downgrading clause can be accommodated by using the "Additional Termination Event" concept.
**Participants considering including this type of clause should carefully consider the possible liquidity implications of the clause. Some banking regulators and rating agencies have expressed concerns as to the impact on liquidity that such a clause could have at the time of a downgrading.**
Where to place the clause. The clause should be inserted at Part 1(g) of the Schedule.
Fallback. The clauses have wording providing a fallback if the description or nomenclature of a credit rating changes or if a named ratings agency ceases to exist.
If the parties want to adopt this option, Item 1(g) of the Schedule to the ISDA Master Agreement should be completed as follows:
"(g) Additional Termination Event will apply.
It will be an Additional Termination Event in relation to a Transaction if a Credit Rating Downgrading occurs.
A "Credit Rating Downgrading" will occur if the credit rating issued by a Ratings Agency for an entity specified below falls below any of the credit ratings specified below for that entity. If the description or nomenclature of a credit rating:
(a) so specified changes or the manner a credit rating is calculated or derived changes after the date of this agreement; or
(b) is different from that specified below because the Ratings Agency is a ratings agency described in paragraph (b) of the definition of Ratings Agency,
then the reference to credit rating in this definition is to be deemed to be the credit rating issued by the relevant Ratings Agency which most closely corresponds to the credit rating set out below.
"Ratings Agency" means:
(a) a ratings agency specified below or any successor of such a ratings agency; and
(b) if such a ratings agency ceases to exist or issue credit ratings, any other agency or organisation which is selected in good faith by the party which is not the Affected Party as being recognised in the global financial markets as a major ratings agency.
Party A is the Affected Party if a Credit Rating Downgrading occurs in respect of Party A or a Credit Support Provider for Party A.
Party B is the Affected Party if a Credit Rating Downgrading occurs in respect of Party B or a Credit Support Provider for Party B.
The following credit ratings apply:
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[Moody's
Investor Service, Inc]
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[Standard & Poor's]
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[Fitch Ratings]
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Party A
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[ ]
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Credit Support Provider for Party A
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[ ]
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[ ]
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Party B
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[ ]
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[ ]
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[ ]
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Credit Support Provider for Party B
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[ ]
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[ ]
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Last Update Date 28 Jun 2011