Australian specific commentary

Australian specific commentary is provided in this section on:

  • "Gaming and insurance legislation";
  • "Termination and damages";
  • "Automatic early termination";
  • "Netting"; and
  • "Set-off".

Australian specific commentary is also provided in 4.1.3 "Insurance legislation", 4.1.4 "Gaming and wagering insurance legislation" and 4.1.5 "Trade practices legislation".

For the purposes of the Australian specific commentary in this Guide, it is assumed that the parties to the ISDA Master Agreement are corporations incorporated under the Corporations Act and that the corporations have the power to enter into both an agreement in the terms of the ISDA Master Agreement and Transactions and have been properly authorised to do so in each instance.  Participants must separately consider the enforceability of the master agreement if they propose contracting with any other type of entity such as a statutory authority or an individual.

King & Wood Mallesons (KWM) is qualified to advise on the laws of the Commonwealth of Australia and of New South Wales, Victoria, Queensland, Western Australia and the Australian Capital Territory only. However, the Corporations Act is uniform throughout Australia.

Gaming and insurance legislation

See the commentary in 4.1.3 "Insurance legislation" and 4.1.4 "Gaming and wagering insurance legislation".

Termination and damages

Sections 5 and 6 deal with early termination of Transactions. 

If Transactions are terminated early, then there are provisions which require payments from one party to the other. The amount payable varies depending on the circumstances which give rise to the termination.

The Master Agreement provides that if a Transaction is terminated, a replacement value for the terminated Transaction must be calculated. 

Of critical importance in the Master Agreement is the definition of Close-out Amount. In broad terms, the Close-out Amount is the amount of losses (or gains) of the party determining the Close-out Amount that are or would be realised under then prevailing circumstances in replacing the economic equivalent of the material terms of the terminated Transactions that would, but for termination, have been required after that date and the option rights of the parties in respect of the terminated transactions. Responsibility for calculating the Close-out Amount rests with the Determining Party, who is required to act in good faith and use "commercially reasonable procedures" in order to produce a "commercially reasonable result".  In addition, the Determining Party may consider "quotations (either firm or indicative) for replacement transactions" supplied by one or more third parties or, alternatively, relevant market data supplied by one or more third parties and relevant market data in the relevant market. 

The calculation of a Close-out Amount under the Master Agreement in respect of the terminated Transactions under the Master Agreement following an Event of Default will be enforceable following the external administration of an insolvent party. This calculation of termination values is expressly permitted under s 14(2)(c) of the Netting Act. The Explanatory Memorandum states that the Netting Act will not apply to contracts where the mechanism for the calculation of the termination value does "not reflect any attempt to calculate the true termination value of the obligation under consideration". It is considered that the Master Agreement does reflect an attempt to calculate the true termination value of the Transactions.

The method provided by the Master Agreement for determining a Close-out Amount does not enjoy a level of specificity sufficient for it to be characterised as requiring the payment of a liquidated (or agreed) sum. [1] Issues regarding the potential characterisation of the Close-out Amount as liquidated damages or a penalty therefore will not arise ordinarily. [2] However, to the extent that the issue of relief against penalties arises in the context of an agreed method of calculating damages, [3]the obligation imposed on the Determining Party to reach a commercially reasonable result means that an Australian court should not view the definition of Close-out Amount as penal in nature. It is therefore considered that the calculation of the Close-out Amount will be enforced by an Australian court provided the calculation arrived at may be properly characterised as a bona fide and genuine pre-estimate of loss.  It follows that parties need to be careful when making the relevant calculation. [4]

A 2002 decision of the Supreme Court of New South Wales on the meaning of "Market Quotation" under the 1992 Master Agreement may mean that the choices made in calculating a Close-out Amount may be subject to challenge in the case of Master Agreements governed by Australian law. [5] The case involved electricity derivatives entered into in Australia within an electricity market that was known for its illiquidity and lack of dealers.

The key issue in the case was whether the Master Agreement in question required Reference Market-makers in furnishing quotations either:

  • to strive to determine or assess the market value of a replacement transaction, or
  • to provide a figure which they considered to be the amount which, if the dealer were quoting on the Early Termination Date, that dealer would quote to be prepared to enter that transaction.

The Supreme Court held that the phrase "that would be paid" appearing in the definition of Market Quotation suggested that the 'market value' interpretation was the most appropriate in this context. The price to be determined was therefore that which "a willing, but not anxious, buyer would pay a willing, but not anxious seller" rather than a price on the side of the bid/offer spread. 

There are strong arguments that the case has been wrongly decided. The decision was appealed but settled on undisclosed terms before the appeal was heard. There is a risk that the decision could be relied on in the future as support for an interpretation of Market Quotation under the 1992 Master Agreement that stresses market value. However, it is important to stress that the decision does not mean that participants should interpret 1992 Master Agreements governed by Australian law as requiring uniform quotations at the midpoint of the spread. There were a number of material factors in the case that were particular to the electricity market at the time of events giving rise to the litigation which may limit the effect of the decision on the broader derivatives market.  These included the illiquidity of the electricity market and that the bid/offer prices referred to in the judgment were identified by independent experts and not dealers. Obiter dictum in the case suggests that in a different fact scenario (ie where there is a liquid market and where quotes are obtained from dealers as opposed to independent experts) quotes on the side of the spread may be acceptable.

The definition of Market Quotation contained in the 1992 ISDA Master Agreement has been replaced in the Master Agreement by the definition of Close-out Amount discussed above.  However, it is doubted whether the Master Agreement expressly negates the approach adopted by the Supreme Court of New South Wales. Accordingly, in respect of Master Agreements governed by Australian law, it is suggested that parties consider inserting the following wording into the definition of Close-out Amount:

"A Close-out Amount is not required to be the market value of the Terminated Transaction or group of Terminated Transactions and, subject to Section 6(e)(ii)(3), the Determining Party is not obliged to use mid-market quotations or mid-market valuations in determining a Close-out Amount."

If this clause (or a clause in similar terms) is inserted into the Master Agreement, it is believed that the construction adopted in Enron will be negated. [6]

In summary therefore the Close-out Amount concept in the Master Agreement would be enforceable under Australian law provided the calculation arrived at may be properly characterised as a bona fide and genuine pre-estimate of loss.

Automatic early termination

It has been concluded (see [2.18] of 4.3.3 "Netting") that there is no advantage under the laws of the Australian Jurisdictions in providing for automatic termination and that it is preferable for the Non-defaulting Party to control the timing of the early termination. Accordingly, it is recommended that participants elect that "Automatic Early Termination" does not apply.

Care! It is understood that there are some jurisdictions in which the concept of automatic termination could be useful. These include Germany, Japan, Canada and Italy. The recommendation to remove the concept of automatic termination should be carefully reviewed if one of the parties to an ISDA Master Agreement is a non-Australian incorporated entity.


Section 2(c) provides for the netting of payments due on the same day, in the same currency and in respect of the same Transaction. The parties can extend the payments netting for payments due in the same currency on the same day to all or a group of Transactions or between pairings of Offices (see "Part 4(i) - Netting of payments - Multiple Transaction Payment Netting").

It is concluded that if the parties want to adopt netting for credit assessment purposes, then no amendments need be made to an ISDA Master Agreement.  6.2 "History" contains further information on why the Australian Addendum No. 10 which it was recommended be used prior to July 1998, is no longer required. Later the Guide (see [1.04](g)-(j) of 4.3.3 "Netting") lists:

  • provisions of an ISDA Master Agreement which must not be altered; and
  • provisions which must not be incorporated into the Master Agreement,

if parties want to ensure that netting under their ISDA Master Agreement is enforceable.

KWM has issued an opinion to AFMA for the benefit of AFMA and its members in relation to the enforceability of close-out netting under the laws of various Australian jurisdictions. This opinion can be viewed in   "KWM legal opinion on Enforceability of Close-out Netting".

KWM has also issued an opinion to ISDA for the benefit of ISDA and its members.  The opinion is available to ISDA members in the "ISDA member's portal". 

The opinions are based on the assumptions and qualifications set out in the opinions, including that none of the circumstances are present which could affect the availability of the Netting Act.

Further information on netting can be found in 4.3 "Netting".  This includes a legal analysis of netting based on the assumption that the Master Agreement is governed by "Australian Law" (as defined in the analysis).


The ISDA Master Agreement contains a general set-off provision (Section 6(f)). Each participant needs to be satisfied as to the commercial acceptability of such a clause. It may be that there will be some obligations which a market participant would want to exclude from such a set off arrangement.

For example, it is common in securitisation transactions for the rating agencies to require that the parties do not include any set-off provision in the ISDA Master Agreement. This reflects the rating agencies' view that the swap counterparty should be paid in accordance with the cash flow methodology set out in the transaction documents.

Section 6(f) of the ISDA Master Agreement is a set-off clause. Prior to the publication of the 2002 ISDA Master Agreement this clause was set out in the User's Guide to the 1992 ISDA Master Agreement at page 56 as a suggested form of set-off clause ("ISDA's 1992 basic set-off clause"). Up to 31 May 2002 the Guide contained two suggested set-off clauses one which did not provide for set-off in respect of amounts contingently owing and one which did.  The wording of each of those clauses can be found in the history files for parts 5 and 18 of the hard copy Guide dated 31 May 2002 (see 6.2 "History").)

AFMA no longer recommends the use of these set-off clauses. Instead, AFMA recommends that Section 6(f) of the ISDA Master Agreement is acceptable subject to the following comments.


The User's Guide to the 1992 ISDA Master Agreement contains example drafting and commentary for various types of set-off clauses (see pages 54 to 58 of the User's Guide). ISDA's 1992 basic set-off clause is one of these.

The history version for part 5 of the hard copy Guide dated 31 May 2002 contains a commentary on the differences between ISDA's 1992 basic set-off clause and the AFMA clause (see 6.2 "History").

Section 6(f) is not identical to ISDA's 1992 basic set-off clause.

The reasons AFMA no longer recommends the AFMA clause include:

  • Where a form of document is widely accepted globally, AFMA's Documentation Committee believes it has become increasingly desirable to match the document used in Australia with the document used globally. An exception to this is where there is a specific Australian legal, regulatory or market reason that justifies a difference. The Committee does not believe there is a specific Australian difference that justifies the separate clause in this case.
  • The AFMA clause gives the option about whether or not to set-off only to the party obliged to make the payment under the ISDA master agreement.  This could be the Defaulting Party or the Affected Party (in which case the non-Defaulting Party or non-Affected Party would not have the right to set-off under the clause). Section 6(f) allows a set off only at the election of the non-Defaulting Party or non-Affected Party.
  • The AFMA clause was drafted to allow the payer to elect the set-off as this reflects Australian insolvency law. On insolvency of a party, the mandatory insolvency set-off provision contained in the Corporations Act (s 553C) will operate to set-off amounts owing mutually between the parties. A clause which purports to limit set-off to when it is conducted at the option of the non-Defaulting Party will not be enforceable in restricting set-off following insolvency.
  • While this issue still remains, it is recognised that Section 6(f) will be effective before insolvency (this was acknowledged in the commentary to the AFMA clause). Accordingly, in the interest of achieving global consistency AFMA has concluded that there is no legal reason why Section 6(f) cannot be used under Australian law.  However, participants must appreciate that it will not operate to prevent the mandatory set-off law from operating following insolvency.
  • The reason why the payee was not given the option to elect to set off was because of a view that the question of whether a payer should be able to set-off should be covered in the agreement under which the obligation to pay arises.  If the payee under an ISDA Master Agreement wants to require the other party to set off, it means that the payee must be a "payer" under another agreement between it and the payer under the ISDA Master Agreement. When the original AFMA clause was prepared it was considered at that time appropriate that a payee under an ISDA Master Agreement should cover its ability to set off payments due under other agreements under the terms of those other agreements. For example, the parties may enter into an agreement where they agree that payments under it must be made "without set-off or counterclaim".
  • Section 6(f) could operate to override other agreements that prohibit set-off and participants who decide not to amend Section 6(f) should be satisfied that they are agreeable to this possibility. That said, AFMA has again concluded that, despite this issue, it is preferable to achieve global consistency with the set-off clause.
Some points market participants should consider when deciding whether Section 6(f) is acceptable to them include:
  • Section 6(f) contemplates the set-off of contingent amounts whereas the AFMA clause previously contained in the Guide did not. AFMA's alternative set-off clause (now contained in the history version of part 18 dated 31 May 2002 (see 6.2 "History") gives more detail about the mechanism for setting off contingencies than does Section 6(f). While some market participants may prefer this approach, the Committee takes the view that the level of detail in this context is not an issue driven by Australian law, regulation or market practice.
  • Under Section 6(f), conversions from one currency to another are done at the rate of exchange at which the Non-defaulting Party or Non-affected Party "would be able, acting in a reasonable manner and in good faith, to purchase the relevant amount of such currency". This differs from the formulation used in AFMA's set-off clause.
  • ISDA's basic set-off clause does not permit set-off by either party if there are two Affected Parties or for Termination Events other than Credit Events Upon Merger or a Termination Event in respect of which all outstanding Transactions are Affected Transactions. This is presumably on the view adopted by the drafters that set-off should be claimed by a Non-defaulting Party or a Non-affected Party only in those limited circumstances and that, otherwise, contractual set-off should not be permitted and payments be made as they fall. Participants should be satisfied with this approach.
  • It is common in securitisation transactions for the rating agencies to require that the parties do not include any set off provision in the ISDA Master Agreement. This reflects the rating agencies' view that the swap counterparty should be paid in accordance with the cash flow methodology set out in the transaction documents.

[1] See Public Works Commissioner v Hills [1906] AC 368 at 376.

[2] See e.g. Greig & Davis, The Law of Contract, Law Book Company, Sydney, 1987, pp1447-8; Parkinson (ed), Principles of Equity, Law Book Company, 1996 p286.

[3] See Chitty on Contracts, Sweet & Maxwell, London, 1999, p1274.

[4] In this context it is noted that Section 6(e)(iv) of the Master Agreement varies from the 1992 Master Agreement by the deletion of the words "if Market Quotation applies". It is doubted whether an Australian court would give effect to Section 6(e)(iv). In other words, it is doubted whether an Australian court would accept that any amount determined by the Determining Party under the Close-out Amount definition is a reasonable pre-estimate of loss. Instead it will want to be satisfied with the actual calculation.

[5] Enron Australia Pty Limited (in liquidation) v Integral Energy Australia [2002] NSWSC 753.

[6] Whether or not this clause is included is irrelevant to the conclusion in [2.08] of the opinion in 4.3 "Netting" on whether the ISDA Master Agreement is a close-out netting contract for the purposes of the Payment Systems and Netting Act.

Last Update Date 03 Sep 2018