Timothy Hughes, Lisa Mantello, Elizabeth Mpermperacis
Mar 24, 2020
As the COVID-19 pandemic continues to impact financial markets world-wide, there may be significant implications for market participants in the derivatives industry. This article highlights certain issues that these unprecedented circumstances may raise with respect to the 2002 ISDA Master Agreement in particular, and provides practical tips for counterparties who are currently active in the market.
Key Tips for Market Participants:
- Proactively review your agreements for consequences of market disruption—You may have deferral rights for an inability to perform certain obligations in the event of a market shut-down or disruption. It is important to understand what those rights are ahead of time and plan for the alternatives.
- Keep your notice information up to date—This applies both to emergency contacts at regulatory bodies and the notice information for various delivery and service mechanics in the ISDA Master Agreement. As organizations pursue remote work models and temporary office relocations to protect the health and safety of their workforce, making sure the official lines of communication remain open (in accordance with the terms of your agreements) is essential to the continuity of your trading relationships.
- Review your documentation as a whole—The hallmark of the ISDA “suite” of agreements is that the documents that comprise it are largely interdependent. It is important to review the Master Agreement itself, the schedule, credit support documents, and confirmations, as well as any agreements that these documents might reference, to get the full picture of what circumstances would trigger a default or otherwise impact a parties’ ability to perform.
- Review business continuity plans—Focus on what your organization needs to do to keep your derivatives trades active and comply with your obligations.
Potential Issues Under the 2002 ISDA Master Agreement:
1. Market Disruptions
- This is already playing out internationally, with markets and systems in the Phillipines and Mauritius closing over the past week and the CBOE Options (C1) trading floor in Chicago closing indefinitely as of March 16. Measures are also being looked into in France concerning the postponement of debts due by French companies.
- If a jurisdiction in which a counterparty has its office declares a closure of the banks in that jurisdiction or a settlement system is otherwise not open or operating, the 2002 ISDA Master Agreement accounts for the following possibilities:
- Deferral of payment default: If payment cannot be made as a result of the disruption, it may not be an immediate default. Parties should consider what day the payment will be deferred to, and what the impact might be on interest periods and accruals.
- Valuation difficulties: If markets are not available, it could affect the ability of market participants to obtain the value of their trades and collateral. Pursuant to the 2002 ISDA Master Agreement, the valuation date would be postponed for up to the Waiting Period, which is eight scheduled trading days to prevent a default from occurring as a result.
- Settlement disruption: If settlement of a trade is not possible because clearing systems are disrupted, the same eight scheduled trading day Waiting Period would apply before occurrence results in a default.
- Parties should review their negotiated Schedules to understand the impact of any amendments to these provisions.
2. Operational Difficulties
- Notice and Delivery of Service: Practical operational roadblocks may arise as a result of either a government-imposed lock-down in the region in which the party operates, or due to remote work policies. For the purposes of the 2002 ISDA Master Agreement, this may affect:
- service of papers, as under the Agreement you must serve in accordance with the Schedule; that is, each party must agree with their counterparty to an alternative method of service if the current method (in person delivery or fax) is not available; and
- close-out notices, which have the same delivery restrictions built into the Agreement as apply to service of papers .
Parties should review the Schedule for any negotiated alterations to the notice and delivery provisions, particularly any provisions regarding deemed receipt.
- Regulatory Reporting Requirements: Operational changes and large-scale reliance on untested business continuity plans may make meeting regulatory reporting obligations difficult. Parties should review their reporting requirements with an eye to assessing their ability to meet deadlines and potential runways for compliance where this is not possible. Regulators are endeavouring to put relief measures in place to accommodate the unique circumstances that market participants are currently navigating—as a result, requirements are a moving target.
- Force Majeure: Where there is no unscheduled bank closure, parties may look to the force majeure provision in the 2002 ISDA Master Agreement if they are unable to perform their obligations.
- The availability of this defence is fact-driven and requires the parties to meet the extremely high thresholds of impossibilty or impracticability of performance. Parties are encouraged to consider their ability to perform on a case-by-case basis with counsel to determine their options. If the force majeure defence is available, the effect is a deferral of the relevant payment or delivery obligations for up to eight scheduled business days.
- If the obligations in question are continuing, or the obligations are under a credit support document rather than the Master Agreement, a force majeure event will give either party a termination right.
- Note that the China Council for the Promotion of International Trade issued a force majeure certificate in relation to COVID-19 in February. It is possible that other governments internationally may consider doing the same. This may affect the assessment of whether the force majeure clause will apply.
- Outside of the force majeure defence, there may be negotiated or common law defences available. Parties should review their agreements to determine the options available to them.
4. Cross Default
- The impact of the COVID-19 pandemic on the financial health and ongoing operations of market participants means that it is very likely that other agreements may be impacted. Review your ISDA agreements to determine which other contracts might trigger a cross-default.
If other governments impose postponements of debts, such as that currently being considered by the government of France, the default provisions of the relevant debt facility should be carefully reviewed to understand whether a technical default due to non-payment is triggered, regardless of whether the lender is permitted by law to call the loan. If a technical default has still occurred, there may be a cross-default under any associated ISDA agreement.