On February 21, the International Swaps and Derivatives Association, Inc. (“ISDA”) announced the publication of the 2014 ISDA Credit Derivatives Definitions (the “2014 CD Definitions”), which amend several terms that existed in the 2003 version of the definitions, and introduce several new terms based on “lessons learned.”

The most important new terms in the 2014 CD Definitions are in response to events affecting financial institutions and sovereign entities that have occurred since the introduction of the 2003 version of definitions, including governmental interventions in bank debt.  These new terms include an entirely new credit event known as “Governmental Intervention,”^[1] which is intended to be triggered upon a government-initiated “bail-in”^[2] or debt restructuring, as well as a provision for delivery of instruments resulting from a government-initiated debt exchange. READ MORE →

The International Swaps and Derivatives Association, Inc. (“ISDA”) is preparing forms of amendment to its boilerplate master agreements in connection with market practice relating to the suspension of payments by a non-defaulting party. ISDA is also considering a protocol to implement the amendments into existing agreements on a multilateral basis.

Currently, Section 2(a)(iii) of the ISDA master agreements permits a non-defaulting party to indefinitely withhold scheduled payments it owes on transactions while at the same time not requiring that party to terminate its outstanding transactions. This contractual provision has been treated differently across jurisdictions in disputes. Most recently, cases relating to the Lehman bankruptcy, both in New York and in the United Kingdom, have brought additional attention to this provision. In one case, known as Metavante (2009), a New York bankruptcy court concluded that by failing to terminate its existing transactions with Lehman for more than 11 months after its bankruptcy filing, the non-defaulting party had waived its right to terminate pursuant to the “safe harbor” provisions of the U.S. Bankruptcy Code and, therefore, no longer had the right to suspend scheduled payments. In another case, known as Lomas (2010), the English High Court decided that the non-defaulting party could withhold scheduled payments indefinitely (i.e., the court refused to imply that the parties had intended to limit such a suspension only for a “reasonable period”), and that the non-defaulting party was not obligated to terminate its five outstanding swap transactions (in which case it would have owed Lehman some US$57.3 million). The Lomas court also concluded that any suspended payments would be extinguished on the last scheduled payment date of a transaction, provided that the condition precedent had not been satisfied (i.e., the default had not been cured) at such time.

The original intent of Section 2(a)(iii) was to protect a non-defaulting party from increasing its exposure to a defaulting party (or a party that was approaching default). However, the conflicting decisions present significant uncertainty and litigation risk for market participants and have, in some respects, upended market expectations. As a result, ISDA is considering certain amendments that would clarify and restrict a non-defaulting party’s rights under Section 2(a)(iii). Specifically, ISDA may consider proposing a time limit for suspension of payments (e.g., 90-180 days after a party withholds a scheduled payment), after which a non-defaulting party must perform or terminate. ISDA also may consider clarifying that a party’s obligation to pay suspended payments survives—and is not extinguished—upon the scheduled termination of the relevant transaction. Of course, even with these amendments, contractual provisions permitting a party to suspend payments to a bankrupt entity would be subject to applicable local bankruptcy law.

On April 23^rd, ISDA released preliminary results from its 2010 ISDA Margin Survey (the “Margin Survey”).  Eighty-nine (89) firms responded to the Margin Survey, seventy (70) of which were banks or broker-dealers.  The results of the Margin Survey demonstrated that the use of collateralization as a mitigant for counterparty credit risk continued to expand.

According to the Margin Survey, seventy-eight percent (78%) of all OTC derivatives transactions now entered into among large dealers are subject to collateral agreements.  Such arrangements are especially common for credit derivatives, with ninety-seven percent (97%) of such transactions being subject to collateral agreements.

The Margin Survey reported that there are now almost 172,000 collateral agreements in place, eighty-three percent (83%) of which are bilateral arrangements under which either party may be required to deliver collateral; last year’s margin survey reported that only seventy-five percent (75%) of collateral agreements provided for bilateral arrangements.

ISDA pointed out in connection with the publication of these preliminary results that the association and the industry in general had made significant improvements in the area of collateralization.  In particular, it noted that approximately ninety percent (90%) of Margin Survey respondents indicated that they periodically perform “portfolio reconciliations”^[1] (the major dealers were doing so on a daily basis) and that extensive progress had been made, in cooperation with global regulators, to strengthen the operational infrastructure of market participants.

^[1] For an additional discussion of portfolio reconciliation efforts, see the January 2010 Derivatives Month in Review.

On March 1^st, the International Swaps and Derivatives Association, Inc. (“ISDA”), the Managed Funds Association and the Securities Industry and Financial Markets Association jointly published a Whitepaper (the “Whitepaper”) on Independent Amount.  On the same date, ISDA also published a market review of over-the-counter (“OTC”) bilateral collateralization practices (the “Market Review”).  The Whitepaper and Market Review were developed for the purpose of better understanding current derivative market practices surrounding collateralization, a key method of mitigating counterparty risk in exchange-traded and, especially, OTC derivatives.  The documents make specific recommendations (including for legislative and regulatory changes in certain jurisdictions) for market participants to improve or enhance their collateral management practices. READ MORE →

On March 1^st, ISDA and twenty-five (25) market participants submitted to the Federal Reserve Bank of New York, as well as to other global supervisors, a letter (the “Industry Letter”) detailing the steps the industry has taken to improve the framework for OTC derivatives transactions and making additional commitments.  The Industry Letter is the sixth in a series of letters addressing how the industry will work to, among other things, strengthen the robustness of OTC derivatives markets infrastructure and improve transparency. READ MORE →

On January 14, 2010, the Federal Reserve Bank of New York (the “Federal Reserve”) hosted a meeting of major market participants, including both major dealers and buy-side participants, industry groups (including the International Swaps and Derivatives Association, Inc. (“ISDA”), the Securities Industry and Financial Markets Association and the Managed Funds Association) and domestic and international supervisors.  The purpose of the meeting, the sixth such meeting with industry participants held at the Federal Reserve, was to discuss efforts to improve the infrastructure supporting the over-the-counter (“OTC”) derivatives market.

At the meeting, William C. Dudley, president of the Federal Reserve, noted that the industry needed to continue its efforts to bring greater transparency to the derivatives markets and reduce systemic risk.  Market participants updated the Federal Reserve on developments in the derivatives market and agreed to effect additional changes to reduce risk and increase transparency.  In particular, the market participants agreed to: (i) expand central clearing for interest rate swaps and credit derivatives (including expanding the range of products eligible for central clearing), (ii) expand reporting on OTC derivatives transactions to regulators and (iii) improve risk management for derivatives transactions that are not centrally cleared by formalizing “best practices” for managing the risks inherent in these transactions, including through collateralization.  These commitments are in addition to the commitments market participants have made to regulators to report non-cleared trades to central repositories and to work with central clearing parties to broaden the range of cleared products.  The market participants agreed to provide a letter to the regulators by March 1, 2010 detailing their progress on these new commitments.

On December 18, 2009, the ISDA Collateral Committee published a study (the “Study”) on the feasibility of extending collateral portfolio reconciliations (the complete Study may be found at this link).  Since July 2008, ISDA and derivatives markets participants have made a series of commitments to regulators regarding collateral management.  These commitments have included enhancing portfolio integrity between pairs of derivatives counterparties, known as portfolio reconciliation.  In particular, industry groups and market participants have recognized the need to (i) agree to the existence and general economic terms of the transactions between them and (ii) agree to the mark-to-market value of those transactions (within some reasonable tolerance of difference). READ MORE →