Key Points: ISDA's clarification will put a time limit on how long
the non-defaulting party is entitled to suspend its obligations
under Section 2(a)(iii).
The legal session at the ISDA AGM covered a broad range of
documentation developments, including updates to the ISDA Equity
Derivatives Definitions and the development of a new Master
Bridging Agreement to allow netting of cleared (through central
counterparties) and uncleared products governed by separate ISDA
However, the key focus of the legal session was ISDA's
response to the growing uncertainty in the OTC derivatives market
over the correct interpretation of Section 2(a)(iii) of the ISDA
Master Agreement, which deals with a party's right not to pay
or deliver if there is a default (or potential default event) with
respect to its counterparty.
Section 2(a)(iii) – Reshaping a party's
ability to suspend the obligation to pay or deliver under the ISDA
There have been differing views for some time as to whether
Section 2(a)(iii) should be interpreted so that:
the obligation to pay or deliver under Section 2(a)(iii) is
suspended indefinitely (or subject to a time limit);
the non-defaulting party is owed gross (or net) obligations by
the defaulting party while Section 2(a)(iii) applies.
More recently, these issues have been thrown into sharp relief
by the growing number of recent court cases (including Metavante
and Lomas) and a recent UK Treasury consultation.
ISDA has been working on amendments to clarify the operation of
Section 2(a)(iii) for some time, and on 8 April 2011 released a
Memorandum for Members which proposes the following amendments and
the introduction of a time period for suspension of obligations
of between 90 and 180 days – the expiry of which is
referred to as a "Condition End Date". The Condition End
Date will determine how long a non-defaulting party can suspend
performance of its obligations following a default by the
Section 2(a)(iii) applies only to the parties' net
obligations after the operation of Section 2(c). In other words,
the defaulting party's ongoing obligations subject to the
suspension are netted against payments due by the
the obligations of the non-defaulting party affected by Section
2(a)(iii) are suspended rather than fail to come into effect at
the suspended obligations affected by the condition precedent
are required to be performed once the condition precedent in
Section 2(a)(iii) is satisfied, or the Condition End Date is
amendments to align the 1992 ISDA Master with the 2002 ISDA
Master by expressly requiring interest to be paid on suspended
ISDA members had until the end of May to comment on the above
proposals. Once finalised, the amendments are likely to be
implemented via a Section 2(a)(iii) ISDA Protocol.
Time limit issue
The proposed imposition of a time limit on how long the
non-defaulting party is entitled to suspend its obligations under
Section 2(a)(iii) is a particularly significant issue. Its
introduction is being driven by:
a US decision that US bankruptcy law will not allow an
UK decisions that suggest Section 2(a)(iii) is likely to
otherwise offend the "anti-deprivation" principle of UK
bankruptcy law; and
UK Treasury concerns that bankruptcy administrators and
creditors should not have to wait indefinitely to know whether
transactions are being closed out (which has lead to industry
concerns that a time limit may be legislated if the amendments are
Implications for Australia
In Australia, we have usually made our own amendments to ensure
that Section 2(a)(iii) does not have an indefinite operation.
However, if ISDA ends up publishing a Protocol to implement the
proposed changes,we can expect to see the Protocol adopted in
Australia as well.
Overall, the Protocol is very positive for the industry. The
clarifications will enhance the certainty of the ISDA Master
Agreement and may avoid some of the contrary interpretations that
have been proposed as to how Section 2(a)(iii) is intended to
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