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Overnight, the International Swaps and Derivatives Association,
Inc. (ISDA) published the latest instalment in its
roll-out of documentation developed in response to the United
States Dodd–Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act).
ISDA's Tri-Party IA Notices (Notices) are
the latest addition to a suite of ISDA published templates to
facilitate the negotiation of tri-party control agreements
associated with non-centrally cleared over-the-counter
(OTC) derivatives contracts.
This initial margin is contractually referred to in ISDA
documentation as the "Independent
Amount", and although it gives comfort to dealers, it
creates risks for end-users if collateral posted as an Independent
Amount is intermingled with the dealer's assets. If the dealer
becomes insolvent, the end-user may find itself in a queue to
recover its initial margin with all of the insolvent dealer's
other ordinary creditors. Full recovery in that situation is very
unlikely.
To protect against this situation, parties can enter into a
tri-party control agreement to ensure that the Independent Amount
is retained in a segregated account by a custodian third party. In
fact, the Dodd-Frank Act will require dealers and major swap
participants in the case of non-centrally cleared derivatives to
notify their counterparties that they have the right to require
segregation of collateral. As a result of these requirements,
tri-party control agreements are expected to become much more
common.
How will the Notices assist?
Tri-party control agreements typically entitle the
non-defaulting party to access collateral held by the custodian on
the occurrence of specified events of default. For example, if the
"secured" party is in default, the party that posted the
collateral (Pledgor) would usually have a right to
access the collateral. Alternatively, if the Pledgor is in default,
the secured party may have that right.
Before it can access the collateral, the non-defaulting party
must, under the terms of the tri-party control agreement, deliver a
notice to the custodian certifying certain matters and notifying
instructions for transfer of the collateral. The Notices published
overnight by ISDA are templates designed to facilitate the
negotiation of the form of such notices by the parties to the
relevant tri-party control agreement.
The publication of the template Notices follows the previous
release by ISDA of sample provisions of tri-party control
agreements as templates to facilitate the negotiation of these
documents. These are available on the ISDA "
Sample Tri-Party IA Provisions" webpage, along with a
memorandum that explains the background to the sample provisions
and information on their use.
Implications for Australia
Australian participants in the OTC derivatives markets that will
be affected by the Dodd-Frank Act will welcome this latest release
by ISDA, as they seek to negotiate the suite of documentation that
will be required once the OTC derivatives rules under the
Dodd-Frank Act come into force.
Clayton Utz communications are intended to provide
commentary and general information. They should not be relied upon
as legal advice. Formal legal advice should be sought in particular
transactions or on matters of interest arising from this bulletin.
Persons listed may not be admitted in all states and
territories.
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