2.1.4.70.2 Early termination - Optional

Some market participants have internal credit assessment requirements under which credit approvals at specified levels will be granted only for a certain time period eg 5 years. This can restrict the ability of the participant to enter into longer term derivative product transactions.

To overcome this problem a number of market participants have prepared a clause (known as an "Early Termination Provision") allowing the early termination of a transaction without cause on certain break dates.

In this part of the Guide two suggested versions of these Early Termination Provisions are published being:

  • For use with the ISDA Master Agreement - where the parties share the bid/offer spread "Early Termination Provision - Parties share bid/offer spread" below.
  • For use with the ISDA Master Agreement - where the terminating party bears the bid/offer spread "Early Termination Provision - Terminating party bears bid/offer spread" below.

Alternatively, clauses allowing the early termination of a transaction without cause on certain break dates can be included in confirmations.

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Clauses

Early Termination Provision - Parties share bid/offer spread

The recommended wording to insert in Part 5 of the Schedule to an ISDA Master Agreement is as follows:

"# Add a new Section [15] as follows:

[15] EARLY TERMINATION PROVISION

(a)         Each party may terminate any Transaction before its stated maturity on a Break Date (being any date specified as such in the relevant Confirmation) by giving a notice (other than by facsimile transmission or electronic messaging system) to the other party not less than twenty (20) Local Business Days before a Break Date. The notice must specify:

(i) the Transaction to be terminated; and

(ii) the Break Date; and

(iii) the date and time when quotes under the fifth paragraph of the definition of Close-out Amount are to be sought.

(b) If a notice is given under paragraph (a):

(i) the Break Date specified in the notice will be deemed to be the Early Termination Date of the Transaction; and

(ii) the obligations of the parties to make any further payments under Section 2(a)(i) on or after the Break Date in respect of the relevant Transaction will terminate and the Transaction will be deemed to be a Terminated Transaction; and

(iii) each party must determine a Close-out Amount on the date and at the time specified under paragraph (a)(iii).

(c) The amount payable under Section 6(e) in respect of the Terminated Transaction is to be determined on the basis that there are two Affected Parties.

(d) Despite Section 6(d)(ii), payment under Section 6(e) must be made on the Break Date specified in the notice.

(e) In determining the Close-out Amount, each party must:

(i) assume that both parties are of the highest credit status (whether or not they have such status); and

(ii) if requested by the other party, indicate the rate or rates on which their Close-out Amounts are based.

(f) Nothing in this early termination provision prohibits a party from specifying an Early Termination Date under Section 6(a) or 6(b)(iv) in respect of the relevant Transaction after the notice is given under paragraph (a). If an Early Termination Date so specified occurs on or before the date that the payment, calculated in accordance with this early termination provision, is due under Section 6(e) in respect of the relevant Transaction, then the notice under paragraph (a) has no force or effect.  Otherwise, the notice under paragraph (a) prevails and any specification of an Early Termination Date under Section 6(a) or 6(b)(iv) has no force or effect."

Early Termination Provision - Terminating party bears bid/offer spread

The recommended wording to insert in Part 5 of the Schedule to an ISDA Master Agreement is as follows:

"# Add a new Section [15] as follows:

[15] EARLY TERMINATION PROVISION

(a) Each party may terminate any Transaction before its stated maturity on a Break Date (being any date specified as such in the relevant Confirmation) by giving a notice (other than by facsimile transmission or electronic messaging system) to the other party not less than twenty (20) Business Days before a Break Date. The notice must specify:

(i) the Transaction to be terminated; and

(ii) the Break Date.

(b) If a notice is given under paragraph (a):

(i) the Break Date specified in the notice will be deemed to be the Early Termination Date of the Transaction; and

(ii) the obligations of the parties to make any further payments under Section 2(a)(i) on or after the Break Date in respect of the relevant Transaction will terminate and the Transaction will be deemed to be a Terminated Transaction; and

(iii) the terminating party is to determine the Close-out Amount except that, in doing so, each reference to "Determining Party" (other than the first reference) in the first paragraph of the definition of "Close-out Amount" is to be taken to be a reference to the non-Determining Party.

(c) The amount payable under Section 6(e) in respect of the Terminated Transaction is to be determined on the basis that there is one Affected Party with the non-terminating party as the Affected Party.[1]

(d) Despite Section 6(d)(ii), payment under Section 6(e) must be made on the Break Date specified in the notice.

(e) In determining the Close-out Amount, the terminating party must:

(i) assume that both parties are of the highest credit status (whether or not they have such status); and

(ii) if requested by the other party, indicate the rate or rates on which their Close-out Amounts are based.

(f) Nothing in this early termination provision prohibits a party from specifying an Early Termination Date under Section 6(a) or 6(b)(iv) in respect of the relevant Transaction after the notice is given under paragraph (a). If an Early Termination Date so specified occurs on or before the date that the payment, calculated in accordance with this early termination provision, is due under Section 6(e) in respect of the relevant Transaction, then the notice under paragraph (a) has no force or effect.  Otherwise, the notice under paragraph (a) prevails and any specification of an Early Termination Date under Section 6(a) or 6(b)(iv) has no force or effect."

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Notes on the Early Termination Provision

Where to place the clause

Both versions have been drafted to be included in Part 5 of the Schedule. The clause is drafted on the assumption that the Break Dates will be specified in the Confirmation for the Transaction subject to early termination.

When the Early Termination Provision is to apply it is suggested that an item be included in the Confirmation as follows:

"Early Termination Provision: The Early Termination Provision in Section [15] of the Agreement applies to this Transaction. The Break Dates are [           ]."

If, instead of including the clause in part 5 of the Schedule, a party wants to use the Early Termination Provision on a case by case basis by inserting it in a Confirmation:

  • replace the bracketed words in lines 2 and 3 of paragraph (a) with "(being [set out dates])"
  • add a new paragraph (g) as follows:

    "(g) References to Sections in this early termination provision are references to Sections in the ISDA Master Agreement between the parties referred to in this Confirmation and terms which have a defined meaning in that Agreement have the same meaning when used in this early termination provision".

Paragraph (a)

In lines 1 and 2 the general words "stated maturity" are used. If a party consistently uses the term "Termination Date" in their Confirmations to describe the maturity date of their Transactions, the party may prefer to replace "stated maturity" with "Termination Date".

Paragraph (a)

If every Transaction is to be subject to the Early Termination Provision and the Break Dates are capable of being defined in general terms (eg each anniversary of the Effective Date), then parties could avoid the necessity of including a reference to the Early Termination Provision in each Confirmation by:

  • deleting the first set of bracketed words in paragraph (a)
  • adding a new sentence after the first sentence in paragraph (a) as follows:

    "A Break Date for a Transaction is any anniversary of its Effective Date".

Paragraph (b)(iii) in "Early Termination Provision - Parties share bid/offer spread" version

This paragraph requires Close-out Amounts to be determined. Some participants prefer to require quotes to be sought from particular third parties. Parties could deal with this in a number of ways:

Third parties to be named in Confirmations.  In paragraph (b)(iii) add a sentence as follows:

"Quotations to be sought pursuant to the fifth paragraph of the definition of Close-out Amount, must be sought from each third party specified in the relevant Confirmation or, if either party considers that such a third party is no longer a leading dealer in the relevant market, from another leading dealer in the relevant market agreed on in good faith by the parties."

If this wording is used, the parties will need to include at the "Early Termination Provision" item in their Confirmation a sentence along the following lines:

"For the purpose of Section [15](b)(iii) quotes are to be sought from the following third parties: [set out names]".

Third parties to be named in the Early Termination Provision. In paragraph (b)(iii) add sentences as follows:

"Quotations to be sought pursuant to the fifth paragraph of the definition of Close-out Amount, must be sought from the following third parties: [set out names]. If either party considers that one of those third parties is no longer a leading dealer in the relevant market, then the quote must be sought instead from another leading dealer in the relevant market agreed on in good faith by the parties".

Paragraph (e)(i)

The clause is drafted on the assumption that there is no credit spread involved in the pricing of the transaction (ie the pricing assumes that both parties are of interbank credit status). If, from the time when the transaction is originally documented to the time when the early termination option is exercised, the credit standing of one of the parties deteriorates, this could have an adverse affect on the other party in relation to the determination of the Close-out Amount. In other words, the third parties could impose a credit spread on the other party thus raising the cost or lowering the profit at which the interbank status party could terminate the transaction.

The wording in this paragraph requires the quotes to be given assuming both parties are of interbank credit status.

If the price at which the parties originally dealt takes account of a credit spread, then it is recommended that:

  • the Confirmation for that transaction sets out the credit spread; and
  • paragraph (e)(i) is appropriately amended to require the third parties to take account of the credit spread affecting the relevant party.

Paragraph (b)(iii) in "Early Termination Provision - Terminating party bears bid/offer spread" version

The clause is drafted on the basis that the terminating party is to determine the Close-out Amount. It has been drafted this way because the terminating party has the greater interest in ensuring that the best quote is obtained to ensure that the transaction is closed out at a neutral level.

The definition of Close-out Amount is drafted so that the Determining Party is to determine its losses and costs (ie generally the Determining Party could be expected to determine its losses and costs at its side of the spread). In this instance, the position needs to be reversed so that the Determining Party (ie the party who wants to terminate) determines the Close-out Amount from the perspective of the non-Determining Party (ie effectively at the non-Determining Party's side of the spread). That is the effect of the wording in paragraph (b)(iii).

 

[1]  The reasoning for the phrase "with the non-terminating party as the Affected Party" in paragraph (c) is as follows. Under paragraph (b)(iii) of this Early Termination Provision it is the terminating party that determines the Settlement Amount. Pursuant to Section 6(e)(iii) and 6(e)(ii)(1), "Non-defaulting Party" in Section 6(e)(i)(iii) equates to the non-Affected Party in Section 6(e)(ii)(1). Therefore, under the standard ISDA Master Agreement, it is the non-Affected Party who determines the Section 6(e)(i)(iii) amount. Therefore, for the purpose of this Early Termination Provision, the non-terminating party needs to be the Affected Party. However, note that paragraph (b)(iii) has the effect that the terminating party must determine the Close-out Amount from the perspective of the non-terminatingparty.


Last Update Date 29 Jun 2011