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1
Commentary on the ISDA Master Agreements
Contents Contents
General Page 3
Preamble Page 6
Section 1 - Interpretation Page 6
Section 2 - Obligations Page 7
Section 3 - Representations Page 7
Section 4 - Agreements Page 8
Section 5 - Events of Default and Termination Events Page 9
Section 6 - Early Termination Page 11
Section 7 - Transfer Page 13
Section 8 - Contractual currency Page 13
Section 9 - Miscellaneous Page 14
Section 10 - Offices, Multibranch parties Page 14
Section 11 - Expenses Page 14
Section 12 - Notices Page 14
Section 13 - Governing law and jurisdiction Page 14
Section 14 - Definitions Page 15
Signatures Page 15
General Page 18
ISDA Amendments Page 18
Other common amendments Page 20
Annex 1 Page 21
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Commentary on the ISDA Master Agreements
This memorandum is intended as an introduction to the 1992 (Multicurrency-Cross Border) Master Agreement (the
“1992 Agreement”) and the ISDA 2002 Master Agreement (the “2002 Agreement” and, together with the 1992
Agreement, the “Master Agreements”). The Master Agreements are published by the International Swaps &
Derivatives Association, Inc. (“ISDA”).
This document is not intended as a comprehensive review nor as a recommendation that a particular type of
agreement is or is not suitable for particular transactions. The commentary is based on the 1992 Agreement and
where applicable, key differences in the 2002 Agreement are referenced. Detailed commentaries on the Master
Agreements can be found in the User’s Guides to the 1992 Agreement and 2002 Agreement published by ISDA.
Defined terms have the meaning given to them in the Master Agreements.
If you require further advice, please see the contact details on the back of this paper.
The Master Agreements may be used to document a wide The Multicurrency - Cross Border version is the most
range of derivative transactions. A list of transactions versatile, and - although it can, of course, be used
commonly documented under them are set out in Annex 1. between parties in the same jurisdiction for transactions
involving a single currency - has been particularly
designed to cater for transactions which are entered into
Master Agreements
between parties in different jurisdictions and/or which
The Master Agreements are designed, amongst other involve more than one currency. It is this agreement
things, to facilitate cross-transaction payment and close-out which is most commonly used and on which this
netting and provide standardisation of terms which are no- memorandum concentrates.
transaction specific. They each contain certain fundamental
standard terms which provide transaction linkage together The 2002 Agreement
with a menu of standard terms which parties can select or The 2002 Agreement updates the 1992 Agreement and
disapply certain matters such as payment netting, events of includes certain new provisions. The 2002 Agreement,
default and other events entitling a party to call for early as with the 1992 Agreement, caters for transactions
termination and to specify details for matter such as entered into between parties in different jurisdictions
transfers and notices. and/or which involve more than one currency.
The 1992 Agreement In brief the key changes which have been made are:
At the core of the ISDA documentation framework is the
a. providing for Force Majeure as a new Termination
1992 Agreement. There is also a Local Currency – Single
Event;
Jurisdiction version of the 1992 ISDA Master Agreement
b. providing a new methodology for close-out
calculations;
c. reducing the grace period for the Failure to Pay or
Deliver Event of Default from 3 to 1 Local Business
Days;
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Commentary on the ISDA Master Agreements
d. some hardening of the Bankruptcy Event of Default; altered. The advantage of standardisation is lost if it is
e. expansion of Breach of Agreement Event of Default to not clear whether provisions of the standard forms have
include repudiation; been changed.
4
The 1995 Credit Support Annex (Transfer – English These termination and close-out provisions enable
Law). This is governed by English law and rather than parties significantly to reduce their exposure to the other
creating a security interest in the collateral, it requires an party for credit and capital adequacy purposes.
outright transfer of cash and/or securities. As with the
New York law CSA, it forms part of the main master Capital adequacy and netting
agreement when adopted.
For capital adequacy purposes, regulators in most
The 1995 Credit Support Deed (Security Interest –
countries permit banks and other financial institutions to
English Law). This is an English law document which
use net exposures for capital adequacy purposes where
operates by way of creation of a security interest in cash
the relevant bank or other institution has an effective
and/or securities. It is a stand-alone document and is
netting agreement in place.
likely to require registration at the Companies Registry
under UK companies legislation. For this reason There are several requirements which normally need to
(amongst others) it is not widely used. be met before a bank or other financial institution can
There is also a User’s Guide for the two English law use close-out netting provisions in an agreement as an
credit support documents. effective means of reducing credit exposures. These
requirements were originally based on the July 1994
The 1995 Credit Support Annex (Japanese Law). Amendment to the Capital Accord of July 1988 adopted
This document is only used where the parties intend to by the Basel Committee on Banking Supervision (part of
use assets located in Japan as credit support. Due to its the Bank for International Settlements). The update to
limited scope, it is not considered further in this the 1998 Accord (“Basel II”) has now been published by
memorandum. There is a User’s Guide accompanying the Basel Committee and was implemented in the end of
this document. 2007. For the consolidated text of Basel II, see the
All four forms of collateral agreement are intended for use International Convergence of Capital Measurement and
in bilateral mark-to-market arrangements. However, they Capital Standards published by the Basel Committee in
can readily be adapted to provide for one-way June 2006.
arrangements (where only one of the parties is required to
put up security or transfer assets). The requirements for an “effective netting agreement”
under the 1998 Accord and Basel II are broadly the
They were each drafted with the 1992 Agreement in mind same and include the following:
and need to be amended for use with a 2002 Agreement.
This can easily be done by incorporation of the 2002 a. The party seeking to rely on the netting agreement for
Master Agreement Protocol which contains the necessary capital adequacy purposes must hold reasoned legal
changes. opinions on the enforceability of the close-out netting
provisions in each relevant jurisdiction.
Termination and close-out netting
In this regard, ISDA have commissioned numerous
One of the biggest advantages of the Master Agreements is legal opinions on the enforceability of these
the ability of the parties to terminate all outstanding provisions. In particular, opinions have been obtained:
transactions if certain specified events (called Events of
Default and Termination Events in the Master Agreements) as to the enforceability of these provisions
occur in relation to one of the parties. Such a termination of under English law and New York law (which
all transactions is known as a close-out. are the laws which the parties can select to
govern the Master Agreements); and
When a close-out occurs the Master Agreements provide a
as to the enforceability of these provisions in
mechanism for the calculation of the present value (or
the event of the insolvency of one of the
termination cost) of all obligations in respect of outstanding
parties organised and/or acting through a
transactions and the calculation of a single net obligation of
branch in various jurisdictions.
one party to make a payment to the other in respect of all
such obligations. (The termination and close-out netting
provisions of the 1992 Agreement are considered in more The legal opinions are addressed to ISDA and may
detail in Section 2 below.) be relied upon by members of ISDA.
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Commentary on the ISDA Master Agreements
It is often the case that parties enter into Transactions prior Where ISDA Definitions (e.g. the 2006 ISDA
to signing the Master Agreement. For this reason, the Definitions for interest rate derivatives) are to be
Master Agreement is expressed to be “Dated as of ...” incorporated into Confirmations, it is not uncommon
rather than “Dated …”. This wording means that a Master also to incorporate these in the Schedule. It is,
Agreement can be expressed to take effect from a date however, preferable to deal with them in
before the date on which it is actually signed. This is also Confirmations only as the Definitions are updated
reflected in the execution wording on page 18, which from time to time and it is important to be clear which
envisages signing taking place on one date but the edition applies to a particular Transaction.
agreement having effect from another. In practice the trade b. Where there are discrepancies, the Schedule prevails
date of the first Transaction is generally chosen unless the over the printed terms of the Master Agreement, and,
agreement is signed before any Transactions have been for a particular Transaction, the relevant Confirmation
entered into. over the printed terms and Schedule. Therefore it is
possible to vary the standard terms either for all
Where Transactions are entered into before the Master Transactions between the parties (by introducing
Agreement is signed, the market practice for drafting changes to the printed terms in the Schedule), or for a
confirmations is to refer to a Master Agreement the parties particular Transaction (by the provisions of the
intend to execute, and until such is executed, deem the relevant Confirmation).
existence of a Master Agreement with no Schedule but just
the basic and essential stated elections sufficient for the
Master Agreement to function as a legal document. At a
minimum, this must include the designation of: (i) the
choice of law; and(ii) the Termination Currency.
6
c. The Master Agreement and all Confirmations are withholding is required by law. Where a deduction or
expressly stated to form a single agreement and it is withholding is required, the affected payment is to be
made clear that the parties are only entering into grossed up, provided that:
Transactions on this basis. In a number of jurisdictions the relevant tax is an “Indemnifiable Tax” (see
this provision may be essential if close-out netting under Section 14) - essentially any tax imposed on a
the Master Agreement is to work. payment other than a tax imposed because of
a connection between the taxing jurisdiction
Section 2 - Obligations and the recipient of the payment or a related
person;
a. Section 2(a) obliges the parties to make the payments or the recipient has not failed to provide any tax
physical deliveries specified in the Confirmations which forms or documents required under Section 4
the parties exchange for particular Transactions. (a)(i) or (iii), or to notify the payer under
Section 4(d) of any relevant change of its tax
Payments and deliveries are conditional upon no Event status; and
of Default or Potential Event of Default with respect to
no payee tax representation given by the
the other party having occurred and continuing and upon
recipient is incorrect other than as a result of
no Early Termination Date for the relevant Transaction
action by a taxing authority or court
having occurred or been effectively designated. “Event
proceedings on or after the date a Transaction
of Default” is defined in Section 5 and “Potential Event of
is entered into or as a result of a change in tax
Default” (an event which, with notice or the lapse of time,
law.
would constitute an Event of Default) in Section 14.
Again, in some jurisdictions this Section can be Under Section 2(d)(ii), where a party fails to make a
important for close-out netting to be effective. Although deduction or withholding from a payment which it is
the Master Agreements contain the principal provisions required by law to make and for which it is not
necessary to deal with payments, for Transactions required to gross up, then the other party must
settled by physical delivery further provisions may be indemnify it against any tax liability which it incurs
required. A number of suggestions are set out in Section as a result, with the exception (if the indemnifying
VI (page 61) of the ISDA User’s Guide to the 1992 party has complied with its tax agreements under the
Master Agreement. Master Agreement) of any penalties.
b. Accounts for payments or deliveries may be changed on e. Default interest is payable under this Section on
five “Local Business Days” notice (“Local Business defaulted payment obligations, up until the occurrence
Days” being defined in Section 14) unless the other party or effective designation of an Early Termination Date,
gives “timely notice” of a “reasonable objection”. after which interest is payable under Section 6(d)(ii).
In the case of defaults in deliveries compensation is
It is not uncommon for the Schedule to limit this right, for payable only if the Schedule or Confirmation provides.
example to prevent changes of jurisdiction without This has changed under the 2002 Agreement.
consent.
c. Payments due on the same date in the same currency in
respect of the same Transaction will be netted.
Section 3 - Representations
The representations set out in this Section are repeated
The parties can, by modifying this provision, also agree by each party on each date on which a Transaction is
that netting of same currency payments due on the entered into and, in the case of the payee tax
same date is to apply across all Transactions, or across representations (Section 3(f)), at all times while the
particular groups of Transactions between particular Master Agreement is in force.
offices. This amendment, however, is not always made
since some market participants lack the appropriate
systems capability to deal with such cross-transactional a. Basic representations
payment netting. These are self-explanatory and cover the following
basic matters:
d. Payments are to be made without deductions or
withholdings on account of tax unless a deduction or
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Commentary on the ISDA Master Agreements
8
Section 5 - Events of Default and iv. Misrepresentation. Any representation, other than
one of the tax representations, is incorrect when
Termination Events
made or repeated.
This Section sets out the Events of Default and Termination v. Default under Specified Transaction. This is
Events following which an “Early Termination Date” may be intended to cover default under other derivative
set for the purposes of the Master Agreement. transactions between one party, its Credit Support
Provider or Specified Entities and the other party, its
Slightly different consequences follow from an Event of Credit Support Provider or Specified Entities.
Default and a Termination Event, though the ultimate effect
- early termination and close-out of all affected The definition of “Specified Transaction” is set out in
Transactions - is the same. However, in broad terms an Section 14 and is very broad, covering most
Event of Default is one for which a party is in some way to transactions which may be entered into under a
regarded to be to blame, whereas a Termination Event may Master Agreement. However, it is sometimes
simply be suffered by, or happen to, a party. amended in the Schedule to broaden or narrow the
types of transactions caught.
The specified events are events which occur to a party
In the 2002 Agreement the definition of Specified
itself, any “Credit Support Provider” (i.e. an issuer of credit
Transaction has been extended to cover, amongst
support such as a guarantee) or any “Specified Entity” of
other things, stock lending and repo transactions but
that party. A “Specified Entity” is an entity specified for this
the Event of Default has been amended so that it only
purpose in the Schedule and would usually be a close
applies where there has been an actual acceleration
group member whose circumstances are likely to impact
to deal with concerns about liquidity issues which can
upon the party itself.
arise in those markets.
vi. Cross Default. This deals with a default by a party,
a. Events of Default
its Credit Support Provider or Specified Entities in
respect of “Specified Indebtedness”.
These cover: “Specified Indebtedness” is defined in Section 14 as
i. Failure to Pay or Deliver. A breach of a payment or any obligation in respect of borrowed money.
delivery obligation. There is a grace period of 3 “Local However, this may again be amended in the
Business Days” (for these purposes, banking days in the Schedule. For example, it may be extended to cover
city specified in the address for notice of the defaulting derivatives, repos or capitalised payments under
party) from the date that notice of such breach is given. leasing obligations. It may also be restricted, by
This is reduced to 1 Local Business Day in the 2002 excluding deposits taken by a bank in the ordinary
Agreement. course of its business.
This Event of Default only applies if it is specified in
It should be noted that, unlike the New York Law Credit Part 1 of the Schedule as applying. If it is “switched
Support Annex and the English law Credit Support on” in respect of one party, then the Event of Default
Deed, this Event of Default (and hence the grace will be triggered where there is a default in respect of
periods) applies to transfer of collateral under an English Specified Indebtedness which exceeds the “Threshold
law Credit Support Annex. Amount”. The “Threshold Amount” must be specified
ii. Breach of Agreement. A breach of any other in the Schedule in respect of each party to which
obligations in the Master Agreement which is not Cross Default applies (see further in Section 3 below).
remedied within a 30 day grace period. vii.Bankruptcy. This essentially deals with the
iii. Credit Support Default. A breach of a Credit Support insolvency of a party, its Credit Support Provider or
Document, a Credit Support Document ceases to be in Specified Entities. It is widely drawn, and covers:
full force and effect before the expiry of the Master dissolution, other than in the course of a
Agreement other than as contemplated by its terms, or consolidation, amalgamation or merger;
there is any repudiation or similar action by a party or its insolvency or inability to pay debts;
Credit Support Provider in respect of a Credit Support
compositions, etc, with or for the benefit of
Document. There are changes to this event in the 2002
creditors;
Agreement.
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Commentary on the ISDA Master Agreements
insolvency proceedings or proceedings for relief likelihood that it will, be required to make a gross-up
under bankruptcy law, which either result in a in respect of Indemnifiable Tax other than in respect
judgment of insolvency or bankruptcy, the of default interest, or will receive a net payment in
granting of such relief or the making of a winding- circumstances when no gross-up is required and it
up order, or which are not dismissed or stayed has not breached its own tax agreements or
within 30 days of institution. This has been representations.
reduced to 15 days under the 2002 Agreement; iii. Tax Event on Merger. This event occurs if there is a
a winding-up or similar resolution, other than merger or similar reorganisation of one of the parties
pursuant to a consolidation or merger; (the “Affected Party”) where such reorganisation is not
the appointment of an administrator or similar a “Merger Without Assumption” (see above) but
representative; results in a deduction on account of tax for which one
party is required to gross up payments to the other, or
enforcement of security or execution of
is required to receive payments net in circumstances
judgments;
in which (other than by reason of its own failure to
any analogous proceedings; or comply with tax covenants or representations) no
any action to further or consent to any of such gross-up is required.
proceedings. iv. Credit Event Upon Merger. This is another event
viii.Merger Without Assumption. This covers a merger or which only applies if specified in the Schedule. If it
other reorganisation of a party or its Credit Support does apply, then it results in a Termination Event if
Provider where the surviving body fails to assume all one party (the “Affected Party”) merges with or
relevant obligations under the Master Agreement or any transfers all or substantially all its assets into another
applicable Credit Support Document or any Credit entity and the resulting, surviving or transferee entity
Support Document fails fully to extend to the is materially less creditworthy than the “Affected
performance by the resulting entity of its obligations Party” immediately before the action.
under the Master Agreement.
This Termination Event was changed in the 2002
Agreement and, in both Master Agreements it is not
b. Termination Events
uncommon to seek to define what “materially weaker”
For the purposes of these provisions it is important to note means.
which party is to be treated as the “Affected Party”, and
Additional Termination Events. This allows additional
also which Transactions are to be treated as “Affected
provisions to be specified in the Schedule if the parties
Transactions”. Which party is the Affected Party differs from
wish to be able to terminate the Master Agreement early
event to event and is specified in the Master Agreement.
for other reasons. It is necessary to specify who the
“Affected Transactions” is defined in Section 14 and
Affected Party is in the Schedule when using this
means, with respect to a Termination Event consisting of
provision.
an Illegality, Tax Event or Tax Event Upon Merger, all
Transactions affected by that event and, with respect to any
The difference between the treatment of Events of
other Termination Event, all Transactions.
Default and Termination Events under the Master
Agreement and the ISDA Credit Support Documents
i. Illegality. This covers events, other than failure to should be borne in mind when deciding to use this
maintain relevant authorisations, which mean that a provision, as opposed to including additional Events of
party (the “Affected Party”) or its Credit Support Provider Default when dealing with any credit sensitive matters.
cannot legally perform its payment or delivery or other
i. Force Majeure. In the 2002 Agreement an additional
material obligations under Transactions or any obligation
Termination Event of Force Majeure applies. This is
under a Credit Support Document.
applies when a force majeure or act of state occurs
ii. Tax Events. This covers any action or proceeding after the date on which a Transaction is entered into
brought by a tax authority, or a Change in Tax Law and a party is prevented from performing its
(defined in Section 14), which has the effect that a party obligations under the agreement because of such
(the “Affected Party”) will, or there is a substantial force majeure or act of state. There is also introduced
the concept of a Waiting Period of up to 8 Local
Business Days.
10
Force majeure is not a term of art under English law and b. Right to terminate following Termination Event
consideration should be given to defining this concept in The consequences of a Termination Event depend on
order to reduce the uncertainty as to whether this event whether one or both of the parties is an “Affected Party”.
has occurred or whether, in fact, an Event of Default has
occurred. Any Affected Party must give notice to the other
promptly on realising that a Termination Event has
c. Hierarchy as between Event of Default and Illegality occurred. Where there is only one Affected Party in the
case of an Illegality or Tax Event, or if there is a Tax
Where one event or circumstance constitutes both an
Event Upon Merger where the Affected Party is the party
“Event of Default” and an “Illegality”, it is to be treated as an
required to make a gross-up or to receive a net payment,
“Illegality”. This may limit the extent to which cross-default
it must use all reasonable endeavours to transfer its
provisions under other arrangements may be triggered for
rights and obligations in respect of Affected Transactions
reasons which are beyond a party’s control. This was also
to another of its offices or affiliates so that the
amended in the 2002 Agreement to reflect the inclusion of
Termination Event will not occur. It has a period of 20
Force Majeure
days from giving notice to the other party of the relevant
event. If it is unable to make such a transfer the other
Section 6 - Early Termination party has 30 days within which itself to attempt such a
transfer. In either case the prior written consent of the
a. Right to terminate following Event of Default other party is needed for the transfer. In the 2002
The consequences of an Event of Default depend on the Agreement, these provisions are no longer applicable to
Event of Default in question and whether “Automatic Early Illegality, only to Tax Events.
Termination” has been specified in the Schedule as
applying. In other cases of any Illegality or Tax Event where there
are two Affected Parties, the parties are required to use
The “Automatic Early Termination” provision allows the reasonable efforts to reach agreement on avoiding
parties to elect that on certain insolvency events (effectively action within 30 days after notice has been given.
dissolutions, compositions, winding-up resolutions, the
appointment of administrators or similar representatives or Failing such solutions, or in any other event, an Early
other analogous events) the agreement will automatically Termination Date may be designated by not more than
terminate and the close-out netting provisions will apply. 20 days’ notice. Who may designate this depends on the
The way in which this option operates is that, where Termination Event in question and in certain instances
“Automatic Early Termination” has been selected and a will be the party to whom the event applies.
relevant event occurs, an “Early Termination Date” is
deemed to have occurred immediately before that event.
c. Effect of designation
This provision is desirable in certain jurisdictions where the Following designation of a Early Termination Date under
insolvency regime might otherwise override the close-out Section 6(a) or (b):
netting by providing that on the onset of insolvency different
i. the agreement will terminate on the designated date,
rules override contractual arrangements.
whether or not the relevant Event of Default or
Termination Event is still continuing; and
In any other circumstance an Event of Default gives the
Non-defaulting Party the right to terminate the agreement ii. the obligation to make further payments or deliveries
and trigger the close-out provisions by designating an Early in respect of “Terminated Transactions” - i.e. all
Termination Date by not more than 20 days’ notice to the Transactions in the case of an Event of Default, and
Defaulting Party. Affected Transactions in the case of a Termination
Event - will end and be replaced by an obligation to
pay the close-out amount.
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Commentary on the ISDA Master Agreements
12
i. Events of Default If “Loss” applies a balance is struck between the party
with the higher “Loss” and the party with the lower
Market Quotation “Loss”.
The Non-defaulting Party will calculate the sum of: (1)
the replacement cost to the Non-defaulting Party of iii. Close-out Amounts
outstanding Transactions (its “Settlement Amount”) and
(2) any unpaid amounts owing to it by the Defaulting In the 2002 Agreement the terms Loss and Market
Party. Quotation are no longer used and the only method of
determining values for close out are the provisions of
If this exceeds the unpaid amounts which it owes to the Close-out Amount, This has simplified the close out
Defaulting Party, the Defaulting Party will be required to provisions somewhat.
pay it the balance.
Where there is an Event of Default, the Non-
If the sum of the amounts above is less than the amount defaulting Party will determine the Close-out Amount.
which it owes to the Defaulting Party, on the other hand, Where there is one Affected Party, the Non-affected
then if “First Method” applies no payment will be made to Party will determine the Close-out Amount, subject,
the Defaulting Party and if “Second Method” applies the however that if the underlying Termination Event is an
Non-defaulting Party will be required to pay the balance Illegality or Force Majeure the Close-out amount will
itself. be calculated on a mid market basis.
Section 7 - Transfer
ii. Termination Events
Where early termination follows a Termination Event the Transfers are prohibited without the other party’s
consequences differ slightly depending whether there is consent except:
one or two Affected Parties.
in the course of a consolidation, merger, etc, which
does not prejudice any other right or remedy of the
One Affected Party
other party under the Master Agreement; or
The non-Affected Party will make the calculations.
in the case of a transfer of a party’s interest in any
If “Market Quotation” applies, the amount payable will be
amount payable to it by a Defaulting Party under
the difference between (i) the sum of the non-Affected
Section 6(e).
Party’s “Settlement Amount” and unpaid sums owing to it
and (ii) unpaid amounts owing by it to the Affected Party.
If “Loss” applies, the amount payable is the non-Affected Section 8 - Contractual currency
Party’s Loss.
This makes clear that payments must be made in the
currencies required under a Confirmation or elsewhere
Two Affected Parties
in the Master Agreement and contains currency
If “Market Quotation” applies, each party determines its
indemnities if payment is made in other currencies.
“Settlement Amount” and a balance is struck between
these and also between the unpaid amounts owing from
each party to the other. 13
Commentary on the ISDA Master Agreements
14
Section 14 - Definitions b. Specified Transaction
This is given a wide definition by Section 14 of
This Section contains most of the definitions used the Master Agreements. However, the
throughout the Master Agreement. definition in the 2002 Agreement extends this
even further and some parties have sought to
incorporate this extended definition into the
Signatures
1992 Agreement. If parties do this then it is
There is a space for signatures at the end of the printed advisable to amend Section 5(a)(v) (Default
terms of the Master Agreement and before the Schedule. Under Specified Transaction) in-line with the
The parties may also sign the Schedule. Though this may 2002 Agreement.
be desirable to establish that the terms of the Schedule are c. Cross Default
indeed agreed, it is not essential. As noted above, the Cross Default Event of
Default only applies if so stated in the
The signature page again reflects the fact that the Master Schedule. Where it does apply, the parties
Agreement may be signed after it is intended to take effect. should decide:
The date to be inserted on the signature page is the date What constitutes “Specified
on which the Master Agreement is actually signed. Indebtedness” for these purposes. As
However, as the signature wording makes clear, once defined in Section 14 this simply
signed by both parties the Master Agreement will take represents indebtedness in respect of
effect from the date specified on the first page. borrowed money. This is generally felt
to be sufficient, particularly in view of
the Event of Default in Section 5(a)(v)
Commentary on the Schedule (Default under Specified Transaction),
which essentially covers default under
References to Sections refer to Sections of the Agreement
other derivative transactions. Some
and references to Parts refer to Parts of the Schedule.
banks, however, like to extend the
definition to include derivatives with
Part 1 - Termination provisions third parties and to exclude deposits
taken in the ordinary course of
a. Specified Entity business. In the first instance care
The purpose of this provision is to extend certain of the needs to be taken to define the amount
Events of Default/Termination Events to third parties of the Specified Indebtedness.
which a party considers to be relevant to its
The level of the “Threshold Amount”,
counterparty’s credit standing - for example, other
being the amount of affected Specified
members of the counterparty’s group.
Indebtedness that must be affected by
the default before the Event of Default
The relevant Events of Default/Termination Events are:
is triggered. Some market participants
like to specify this as a proportion of
It is important to ensure that the entities specified are not
shareholders’ equity or net worth,
drawn from too wide a group. For example, some market
others prefer a specified figure. The
participants like to include all their counterparty’s
latter approach has the advantage of
“Affiliates”. However, Affliates has an extremely wide
certainty, whereas the former may be
meaning (see Section 14) and may be too extensive for
useful where two parties with a
members of a large group of companies. It is normally
significant disparity in size want a
preferable, therefore, to include only named entities.
Threshold Amount that is directly
comparable as between them.
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Commentary on the ISDA Master Agreements
18
b. Set-off f. BBAIRS/FRABBA bridge
These are provisions enabling a party, after Early These are provisions which form a bridge between
Termination, to set-off amounts owing between the other market terms and conditions and the Master
parties in respect of other agreements against the close- Agreement so as to bring the relevant transactions
out payment due under Section 6 of the Master under the Master Agreement. The standard wording
Agreement. The ISDA User’s Guide (pages 54-60) forms a bridge between the Master Agreement and
contains a number of different set-off provisions and a BBAIRS (British Bankers’ Association London
discussion of these and the 2002 Master Agreement Interbank Interest Rate Swaps Recommended Terms
contains a set-off clause as standard. An important point and Conditions) and/or FRABBA (British Bankers’
to consider is whether such a provision should apply Association London Interbank Forward Rate
only as between the parties or whether rights and Agreements Recommended Terms and Conditions).
obligations of affiliated entities should also be taken into
account. It should be noted that there can be difficulties g. CFTC (Commodity Futures Trading Commission)
with provisions which purport to extend to affiliates which representations
could render this provision unenforceable in some These are representations with respect to US Federal
cases. A standard set-off provision is now included in the commodities and futures laws which may be
main body of the 2002 Agreement. appropriate where one of the parties could be subject
to US regulation. This wording is set out in the ISDA
c. Fully satisfied obligations User’s Guides to the Master Agreements.
These are provisions limiting a party’s rights to withhold
payments or deliveries, or to terminate the Master h. Physical deliveries
Agreement, where the other has already performed all of These are supplemental provisions for use where
its payment or delivery obligations (for example, if one of physical deliveries are contemplated. Suggestions for
the parties is a consistent buyer of fully-paid options). the provisions of the Master Agreement which parties
Again, these provisions are set out in the ISDA User’s should consider amending are included in the ISDA
Guide (page 7). User’s Guide to the 1992 Agreement (pages 61-63),
although no actual wording for amendments is given.
The provision which limits the ability of a Non-defaulting
Party to designate an Early Termination Date was
i. Indemnifiable tax
included as paragraph (4) of the May 1989 Addendum in
This is a provision modifying the definition of
relation to interest rate caps, collars and floors and as
Indemnifiable Tax in Section 14 of the Master
paragraph (5) of the July 1990 Addendum in relation to
Agreement so that the range of taxes for which the
options. It is necessary to incorporate this additional
payer may be required to gross up under the Master
paragraph in the Master Agreement if the parties intend
Agreement is increased very slightly. Again, this
it to apply.
wording is set out in the ISDA User’s Guide to the
1992 Agreement (page 48).
d. Impossibility
This is an Additional Termination Event dealing with
j. Jury trial
“Impossibility” which treats Impossibility as a Termination
This is a provision waiving rights to a jury trial. This
Event similar in its effects to Illegality. This Termination
wording may be included by or when dealing with a
Event applies to force majeure situations and may be
US-incorporated party, a US Office of a party or a
particularly appropriate if commodity derivatives are
New York law Master Agreement. Wording is set out
being entered into. This should not be incorporated into
in the ISDA User’s Guide to the 1992 Agreement
a 2002 Agreement as these events should be covered
(page 34) - although shorter form wording is often
by the Force Majeure provisions.
used.
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h. Severability Bullion Option. A transaction in which one party grants
This provision stipulates that the rest of the Master to the other party (in consideration for a premium
Agreement will stand if any of the provisions are held to payment) the right, but not the obligation, to purchase (in
be illegal. the case of a call) or sell (in the case of a put) a
specified number of Ounces of Bullion at a specified
i. ISDA Definitions strike price. The option may be settled by physical
A provision incorporating the 2006 ISDA Definitions (and delivery of Bullion in exchange for the strike price or may
possibly other ISDA Definitions). As noted earlier in this be cash settled based on the difference between the
memorandum, it is preferable to incorporate the market price of Bullion on the exercise date and the
applicable ISDA Definitions in the Confirmation in strike price.
relation to each Transaction. This is particularly the case
as Definitions are up-dated from time to time and it is not Bullion Swap. A transaction in which one party pays
desirable to have to amend the Master Agreement each periodic amounts of a given currency based on a fixed
time the Definitions are up-dated. Care must also be price or a fixed rate and the other party pays periodic
taken to ensure that up-dated Definitions do not apply amounts of the same currency or a different currency
automatically as this could alter the terms of existing calculated by reference to a Bullion reference price (for
Transactions. However, where only short form or example, Gold-COMEX on the New York Commodity
electronic confirmations are exchanged (as is often the Exchange) or another method specified by the parties.
case with FX Transactions and Currency Options), it Bullion swaps include cap, collar or floor transactions in
may be appropriate to incorporate the applicable ISDA respect of Bullion.
Definitions in the Schedule to the Master Agreement
itself. Bullion Trade. A transaction in which one party agrees
to buy from or sell to the other party a specified number
of Ounces of Bullion at a specified price for settlement
j. Transfer
either on a "spot" or two-day basis or on a specified
This is a provision (usually subject to certain conditions)
future date. A Bullion Trade may be settled by physical
entitling one or both parties to transfer Transactions to
delivery of Bullion in exchange for a specified price or
affiliated entities without the consent of the other party.
may be cash settled based on the difference between
the market price of Bullion on the settlement date and
Annex 1 the specified price.
For purposes of Bullion Trades, Bullion Options and
Bullion Swaps, "Bullion" means gold, silver, platinum or
Transactions documented under the
palladium and "Ounce" means, in the case of gold, a fine
Master Agreements troy ounce, and in the case of silver, platinum and
Basis Swap. A transaction in which one party pays palladium, a troy ounce.
periodic amounts of a given currency based on a floating
rate and the other party pays periodic amounts of the same Cap Transaction. A transaction in which one party pays
currency based on another floating rate, with both rates a single or periodic fixed amount and the other party
reset periodically; all calculations are based on a notional pays periodic amounts of the same currency based on
amount of the given currency. the excess, if any, of a specified floating rate (in the case
of an interest rate cap), rate or index (in the case of an
Bond Option. A transaction in which one party grants to economic statistic cap) or commodity price (in the case
the other party (in consideration for a premium payment) of a commodity cap) in each case that is reset
the right, but not the obligation, to purchase (in the case of periodically over a specified per annum rate (in the case
a call) or sell (in the case of a put) a bond of an issuer, of an interest rate cap), rate or index (in the case of an
such as Kingdom of Sweden or Unilever N.V., at a economic statistic cap) or commodity price (in the case
specified strike price. The bond option can be settled by of a commodity cap).
physical delivery of the bonds in exchange for the strike
price or may be cash settled based on the difference Collar Transaction. A collar is a combination of a cap
between the market price of the bonds on the exercise date and a floor where one party is the floating rate, floating
and the strike price. index or floating commodity price payer on the cap and
the other party is the floating rate, floating index or
floating commodity price payer on the floor.
21
Commentary on the ISDA Master Agreements
Commodity Forward. A transaction in which one party Credit Protection Transaction on Asset-Backed
agrees to purchase a specified quantity of a commodity at a Securities. A Credit Protection Transaction for which the
future date at an agreed price and the other party agrees to Reference Obligation is a cash or synthetic asset-
pay a price for the same quantity to be set on a specified backed security. Such a transaction may, but need not
date in the future. The payment calculation is based on the necessarily, include "pay as you go" settlements,
quantity of the commodity and is settled based, among meaning that the credit protection seller makes
other things, on the difference between the agreed forward payments relating to interest shortfalls, principal
price and the prevailing market price at the time of shortfalls and write-downs arising on the Reference
settlement. Obligation and the credit protection buyer makes
additional fixed payments of reimbursements of such
Commodity Option. A transaction in which one party shortfalls or write-downs.
grants to the other party (in consideration for a premium
payment) the right, but not the obligation, to purchase (in Credit Spread Transaction. A transaction involving
the case of a call) or sell (in the case of a put) a specified either a forward or an option where the value of the
quantity of a commodity at a specified strike price. The transaction is calculated based on the credit spread
option can be settled either by physically delivering the implicit in the price of the underlying instrument.
quantity of the commodity in exchange for the strike price
or by cash settling the option, in which case the seller of the Cross Currency Rate Swap. A transaction in which one
option would pay to the buyer the difference between the party pays periodic amounts in one currency based on a
market price of that quantity of the commodity on the specified fixed rate (or a floating rate that is reset
exercise date and the strike price. periodically) and the other party pays periodic amounts
Commodity Swap. A transaction in which one party pays in another currency based on a floating rate that is reset
periodic amounts of a given currency based on a fixed price periodically. All calculations are determined on
and the other party pays periodic amounts of the same predetermined notional amounts of the two currencies;
currency based on the price of a commodity, such as often such swaps will involve initial and or final
natural gas or gold, or a futures contract on a commodity exchanges of amounts corresponding to the notional
(e.g. Light Sweet Crude Oil on the New York Mercantile amounts.
Exchange); all calculations are based on a notional quantity
of the commodity. Currency Option. A transaction in which one party
grants to the other party (in consideration for a premium
Credit Protection Transaction. A transaction in which one payment) the right, but not the obligation, to purchase (in
party pays either a single fixed amount or periodic fixed the case of a call) or sell (in the case of a put) a
amounts or floating amounts determined by reference to a specified amount of a given currency at a specified strike
specified notional amount, and the other party (the credit price.
protection seller) pays either a fixed amount or an amount
determined by reference to the value of one or more loans, Currency Swap. A transaction in which one party pays
debt securities or other financial instruments (each a fixed periodic amounts of one currency and the other
"Reference Obligation") issued, guaranteed or otherwise party pays fixed periodic amounts of another currency.
entered into by a third party (the "Reference Entity") upon Payments are calculated on a notional amount. Such
the occurrence of one or more specified credit events with swaps may involve initial and or final payments that
respect to the Reference Entity (for example, bankruptcy or correspond to the notional amount.
payment default). The amount payable by the credit
protection seller is typically determined based upon the Economic Statistic Transaction. A transaction in which
market value of one or more debt securities or other debt one party pays an amount or periodic amounts of a
instruments issued, guaranteed or otherwise entered into given currency by reference to interest rates or other
by the Reference Entity. Credit protection transactions may factors and the other party pays or may pay an amount
also be physically settled by payment of a specified fixed or periodic amounts of a currency based on a specified
amount by one party against delivery of specified rate or index pertaining to statistical data on economic
Reference Obligations by the other party. A credit conditions.
protection transaction may also refer to a "basket" (ten or
less) or an "index" (eleven to one hundred twenty-five) of
Reference Entities.
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Equity Forward. A transaction in which one party agrees of a specified per annum rate (in the case of an interest
to pay an agreed price for a specified quantity of shares of rate floor), rate or index level (in the case of an
an issuer, a basket of shares of several issuers or an equity economic statistic floor) or commodity price (in the case
index at a future date and the other party agrees to pay a of a commodity floor) over a specified floating rate (in the
price for the same quantity of shares of an issuer to be set case of an interest rate floor), rate or index level (in the
on a specified date in the future. The payment calculation is case of an economic statistic floor) or commodity price
based on the number of shares and can be physically- (in the case of a commodity floor).
settled (where delivery occurs in exchange for payment) or
cash-settled (where settlement occurs based on the Foreign Exchange Transaction. A transaction
difference between the agreed forward price and the providing for the purchase of one currency with another
prevailing market price at the time of settlement). currency providing for settlement either on a "spot" or
two-day basis or a specified future date.
Equity Index Option. A transaction in which one party
grants to the other party (in consideration for a premium Forward Rate Transaction. A transaction in which one
payment) the right, but not the obligation, to receive a party agrees to pay a fixed rate for a defined period and
payment equal to the amount by which an equity index the other party agrees to pay a rate to be set on a
either exceeds (in the case of a call) or is less than (in the specified date in the future. The payment calculation is
case of a put) a specified strike price. based on a notional amount and is settled based, among
other things, on the difference between the agreed
Equity Option. A transaction in which one party grants to forward rate and the prevailing market rate at the time of
the other party (in consideration for a premium payment) settlement.
the right, but not the obligation, to purchase (in the case of
a call) or sell (in the case of a put) shares of an issuer or a Freight Transaction. A transaction in which one party
basket of shares of several issuers at a specified strike pays an amount or periodic amounts of a given currency
price. The share option may be settled by physical delivery based on a fixed price and the other party pays an
of the shares in exchange for the strike price or may be amount or periodic amounts of the same currency based
cash settled based on the difference between the market on the price of chartering a ship to transport wet or dry
price of the shares on the exercise date and the strike freight from one port to another; all calculations are
price. based either on a notional quantity of freight or, in the
case of time charter transactions, on a notional number
Equity Swap. A transaction in which one party pays of days.
periodic amounts of a given currency based on a fixed price
or a fixed rate and the other party pays periodic amounts of Interest Rate Option. A transaction in which one party
the same currency or a different currency based on the grants to the other party (in consideration for a premium
performance of a share of an issuer, a basket of shares of payment) the right, but not the obligation, to receive a
several issuers or an equity index, such as the Standard payment equal to the amount by which an interest rate
and Poor's 500 Index. either exceeds (in the case of a call option) or is less
than (in the case of a put option) a specified strike rate.
Emissions Allowance Transaction. A transaction in
which one party agrees to buy or sell to the other party a Interest Rate Swap. A transaction in which one party
specified quantity of emissions allowances at a specified pays periodic amounts of a given currency based on a
price for settlement either on a "spot" basis or on a specified fixed rate and the other party pays periodic
specified future date. An Emissions Allowance Transaction amounts of the same currency based on a specified
may be settled by physical delivery of emissions floating rate that is reset periodically, such as the
allowances in exchange for a specified price or may be London inter-bank offered rate; all calculations are
cash settled based on the difference between the market based on a notional amount of the given currency.
price of Emissions Allowances on the settlement date and
the specified price. Physical Commodity Transaction. A transaction which
provides for the purchase of an amount of a commodity,
Floor Transaction. A transaction in which one party pays a such as coal, electricity or gas, at a fixed or floating price
single or periodic amount and the other party pays periodic for actual delivery on one or more dates.
amounts of the same currency based on the excess, if any,
23
Commentary on the ISDA Master Agreements
Swap Option. A transaction in which one party grants to determined by reference to a specified notional amount
the other party the right (in consideration for a premium and any depreciation in the market value of each
payment), but not the obligation, to enter into a swap with Reference Obligation.
certain specified terms. In some cases the swap option
may be settled with a cash payment equal to the market A total return swap may (but need not) provide for
value of the underlying swap at the time of the exercise. acceleration of its termination date upon the occurrence
of one or more specified events with respect to a
Total Return Swap. A transaction in which one party pays Reference Entity or a Reference Obligation with a
either a single amount or periodic amounts based on the termination payment made by one party to the other
total return on one or more loans, debt securities or other calculated by reference to the value of the Reference
financial instruments (each a "Reference Obligation") Obligation.
issued, guaranteed or otherwise entered into by a third
party (the "Reference Entity"), calculated by reference to Weather Index Transaction. A transaction, structured
interest, dividend and fee payments and any appreciation in in the form of a swap, cap, collar, floor, option or some
the market value of each Reference Obligation, and the combination thereof, between two parties in which the
other party pays either a single amount or periodic amounts underlying value of the transaction is based on a rate or
index pertaining to weather conditions, which may
include measurements of heating, cooling, precipitation
and wind.
Contacts
This publication is not a substitute for detailed advice on specific transactions and should not be taken as providing legal advice on any of the topics discussed.
Field Fisher Waterhouse LLP is a limited liability partnership registered in England and Wales with registered number OC318472, which is regulated by the Law Society.
A list of members and their professional qualifications is available for inspection at its registered office, 35 Vine Street London EC3N 2AA. We use the word “partner” to
refer to a member of Field Fisher Waterhouse LLP, or an employee or consultant with equivalent standing and qualifications.
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