Editor's note: For a long time, the mainland has formed three major market systems: the interbank OTC derivatives market with NAFMII as the main agreement, the securities and futures OTC derivatives market with SAC as the main agreement, and the over-the-counter market for foreign institutions with ISDA as the main agreement. Among them, the ISDA Master Agreement is an international agreement document issued by the International Swaps and Derivatives Association ("ISDA") to provide certain legal and credit protection mechanisms for parties involved in OTC derivatives transactions. In order to help you understand the functions and characteristics of the ISDA protocol, the CSI Investment Education Base has launched a column entitled "Approaching the ISDA Agreement" to share a comprehensive understanding of the ISDA protocol with all readers.
Cooperative institution: Guotai Junan Risk Management Co., Ltd
*因篇幅所限，本文仅对2002年ISDA协议部分重点条款进行分析思考。 为方便理解，请同时对照参阅ISDA发布的Chinese Translation of the 2002 ISDA Master Agreement-For Educational Purposes Only - Simplified Chinese。
Analysis of the main terms of the ISDA Master Agreement
The primary purpose of the ISDA Master Agreement is to determine how the parties to a transaction will exercise their rights or perform their obligations in the event of an event of default (the breaching party's reluctance to perform) or a termination event (the affected party's inability to perform) under the agreement. Therefore, the most important clauses in the Master Agreement are the core provisions of credit risk management, including "what is an event of default", "what is a termination event", and "how to terminate early and calculate the termination amount". In this issue, I will share some of my thoughts on the termination event and event level of the Master Agreement.
▍ Default events, termination events and processing procedures
条款标题：(b) Termination Events.终止事件
Consider: A party to a transaction may terminate a transaction if the termination event causes a material change in the economics of the transaction or the risk profile of the counterparty. None of the parties are subjectively at fault in a termination event, but the effect of a termination event means that it is financially unreasonable for the parties to proceed with the relevant transaction. There are five types of termination events listed in the ISDA Master Agreement (illegal, force majeure events, tax events, tax events due to merger, credit events due to merger), and a sixth other termination event can be agreed upon. Unlike the ISDA Master Agreement, the NAFMII Master Agreement (domestic version) and the SAC Master Agreement do not contain any tax-related provisions, so there are no two termination events for "tax event" and "tax event due to merger".
In the event of a termination event, it is important to identify the affected party and the affected transaction, as well as determine which party has the right to terminate the transaction early. For a termination event, the party affected by it is often referred to as the affected party. Pursuant to Section 5(b)(i)-(iv) (Unlawfulness, Force Majeure Event, Tax Event, Tax Event Resulting from Merger), if a termination event occurs and the termination is made by announcing an early termination date in the notice, only the single transaction affected by the termination event (the "Affected Transaction") will be terminated. Under Article 5(b)(vi)-(v) (Credit Events and Other Termination Events Due to Merger), the transactions that are normally affected include all transactions and all transactions are subject to termination because the termination event affects the entire contractual relationship. In addition, the parties may elect to terminate less than all of the affected transactions. For example, a party may wish to terminate a short-term foreign exchange or options transaction, but it may prefer to retain a long-term structured transaction that involves high replacement costs. Of course, there is also a risk of "discretionary performance", so the other party also has the right to terminate all or part of the affected transactions that the first party chooses not to terminate on the same early termination date.
A termination event does not include circumstances that constitute an event of default, and if it constitutes both a termination event and an event of default, it may be dealt with in accordance with clause 5(c) "Event Levels" of the Agreement.
条款标题:(e) Illegality.非法
Consider: (1) Section 5(b)(i) provides that a termination event will occur if a party or its credit support provider becomes unlawful to collect, deliver, or comply with any material provision of this Agreement through an agreed office, or if a party or credit support provider's payment or performance in accordance with credit support documents becomes unlawful after the implementation of any duly agreed interruption fallback or other remedy after the implementation of any duly agreed interruption fallback or other remedy. The party affected by the illegal act is the affected party, but either party may request the termination of the transaction affected by the illegal act.
(2) Unlawful conduct does not include any breach by either party of the covenant in Section 4(b) regarding the maintenance of necessary authorizations in connection with the Agreement or any credit support documents. Any such breach will be treated more strictly as an event of default (rather than an illegal act) for breach of the Agreement.
(3) Illegal acts include incidents that occur beyond the control of the parties as a result of government directives or changes in laws, such as the government's implementation of foreign exchange controls. The unlawful act is deemed to have occurred on the date of the event, irrespective of whether payment or delivery was actually due on that date. In addition, the provision makes it clear that if it is illegal for the affected party to pay, receive the goods through the office where the payment or delivery is made, the illegal act will still occur. There is a waiting period of 3 local business days for the unlawful act, and the waiting period is defined in Section 14.
Title of Clause: (ii) Force Majeure Event
Reflections: (1) Force majeure events apply to both parties to the transaction and their credit support providers. A force majeure event is an event that occurs as a result of war, riot, labour disruption, natural disaster or act of state (i.e., invasion by a foreign power) after any agreed interruption or other remedial measures have been implemented:
1) The obligations or rights under the transaction of the office of the affected party cannot be performed or exercised, the material terms of this agreement cannot be complied with, or such performance or acceptance becomes impossible or impractical;
2) The obligations or rights under the credit support documents cannot be performed or exercised, the material terms under the credit support documents cannot be complied with, or such performance and acceptance become impossible and impractical.
(2) It is subject to the fact that force majeure, acts of the State are beyond the control of the Office concerned, the affected party, its credit support provider, and they are unable to overcome such impossible or impractical circumstances with reasonable efforts and minimal cost.
(3) The occurrence of a force majeure event shall be deemed to have occurred on the date of occurrence, whether or not payment or delivery is actually due on that date. The waiting period for a force majeure event is 8 local business days/delivery days, and the termination event will only be constituted if the impossibility or impracticality of the force majeure event continues after the 8 local business days/delivery days have elapsed (during which necessary remedial measures have been taken). During the waiting period, if the force majeure event disappears, the affected party shall perform its obligations on the first local payment date or local delivery date thereafter, and if the force majeure event has not been eliminated after the expiration of the waiting period, either party shall have the right in principle to terminate the affected transaction in advance.
(4) The affected transactions due to force majeure events may be all or partial.
Title of Article: (iii) Tax Event
Consider: (1) After a transaction has been conducted, a tax event occurs when a tax law authority takes action or any action brought in a court of competent jurisdiction (whether or not such action relates to a party to this Agreement), a change in tax law occurs that results in a party being required to withhold tax or the payee receiving a lower payment after deducting the withholding tax. An early termination right arises in this case, as neither party will be considered "at fault" enough to incur unexpected tax charges until the transaction expires. The party that has to withhold taxes as a result of the collection of withholding taxes or who receives less than they anticipate is referred to as the affected party and has the right to demand termination of the affected transactions in accordance with Sections 5(b)(iii) and 6(b) of this Agreement.
(2) If withholding tax is levied under section 9(h) on arrears of interest on late payments in the ordinary course of business, or on interest paid on the early termination of a transaction, no tax event will occur as the amount of such interest is usually small.
(3) Prior to terminating the transaction, in accordance with the procedure set out in clause 6(b)(ii) of the Agreement, "transfer to avoid a termination event", within 20-30 days of the notice, the parties to the transaction shall attempt to transfer the affected transaction to their affiliates (i.e. other companies within the group) or other offices to avoid tax events (which will be discussed in more detail in the next issue).
(4) The basis for terminating an affected transaction is that there is only one affected party, which means that the non-affected party makes the termination calculation. Please note, however, that the affected party cannot unilaterally terminate the affected transaction within 30 days of the notice (subject to the prior written consent of the other party). As a result, the affected party may not be able to take any action on the payments due within these 30 days, i.e. it may have to be paid in total or receive its net payment.
(5) If the payee is unable to receive full payment due to providing a false tax statement or failing to provide the requested tax documents, there is no right to claim a tax termination event. If the facts change at the beginning of the transaction or during the course of the transaction, it does not have the right to trigger a tax event, because the parties involved should be properly analyzed from the outset, and if the facts change at the later stage of the transaction, the transaction cannot be terminated due to their own actions.
(6) Please note that any tax event that affects the payment of the credit support provider is not included in this termination event, as the credit support provider is not included in this termination event.
条款标题：(iv) Tax Event Upon Merger.因合并造成的税务事件
Consider: (1) Under Section 5(b)(iv), a tax event at the time of consolidation will arise if the collection of withholding tax causes the consolidating party to have to increase the payment, or causes the non-consolidating party to deduct the withholding tax upon receipt of the payment due. For example, if the buyer's tax jurisdiction is different from that of the acquired business, such a transaction may result in the collection of withholding tax.
(2) Similarly, only the affected transactions will be terminated. It should be noted that the affected party here refers to the party initiating the merger, and the party that pays an increase or receives a decrease in the amount is called the "burdened party".
(3) In the event of a tax event resulting from the merger, only the encumbered party (not the merger initiator) can terminate the affected transaction, provided that both the encumbered party and the affected party must seek to transfer the transaction to another office or affiliate within 20-30 days of the notice so that the termination event disappears. If the transfer is not possible, the encumbrance party has the right to terminate the affected transaction.
(4) Any termination payments for the affected transaction are calculated on the basis of one affected party, with the non-affected party (i.e., the encumbered party) making the termination calculation. Under section 9(h), tax events at the time of consolidation do not arise as a result of the payment of interest due.
(5) If the transaction is affected by a merger event of default (Section 5(a)(viii)) that does not incur debts, and there will be no tax event at the time of the merger, in which case the transaction may be terminated by an event of default. In contrast, the event of default is more severe and will terminate all transactions under the agreement.
(6) If the payee is not entitled to a lump sum payment due to providing a false payee tax statement, or failing to provide the requested tax documents, there is no right to claim a tax termination event at the time of consolidation.
(7) This termination event does not include any consolidated tax event that affects the payment of the credit support provider because the credit support provider is not included in this termination event.
条款标题：(v) Credit Event Upon Merger.因合并造成的信用事件
Consider: (1) The rationale for a credit event caused by a merger is that if a party knows that its counterparty will be merged or acquired and therefore faces a more serious credit risk, it may not enter into an agreement in the first place. However, the parties will not usually immediately trigger a credit event at the time of the merger, but will work to assess whether the new counterparty will be able to meet its obligations under the agreement, or whether it will need performance security.
The parties to the transaction are required to agree in the ISDA Master Agreement whether one or both parties to the transaction will be subject to the "Credit Event Resulting from the Merger." If the agreement applies to one or both parties to the transaction, this paragraph automatically applies to that party's credit support provider or to a specific institution designated by that party. If the transaction has been consummated, but the ISDA Master Agreement has not yet been entered into, and a party has not communicated to its counterparty during the course of the transaction that the credit event resulting from the merger will apply, nor does the transaction confirmation, then the credit event resulting from the merger will not apply. Given the low probability of such an event, the severity of such a situation is lower than that of a cross-default that would not apply in the same circumstances.
(2) In the event of such a termination event, the affected transactions are all existing transactions of the parties. In the event of an early termination, all surviving transactions will be terminated prematurely.
(3) A credit event resulting from a merger is triggered by: 1) one party, its credit backing party, or any designated authority (the affected party), 2) the occurrence of a merger event, and 3) a significant reduction in its creditworthiness. 4) the merger event did not result in a merger event of default that did not incur a debt (Article 5(a)(viii)).
(4) A credit event arising from a merger means a situation in which a counterparty, its credit support provider or any specific institution is taken over or merged by another entity, resulting in a significant decrease in the creditworthiness of a counterparty or its credit support provider or its specific institution. If the transaction does not result in an Event of Default for the Consolidation of Unincurred Obligations (Clause 5(A)(viii)), a "Termination Event" will occur under these Terms. Accordingly, in the event of a credit event resulting from a merger, a party or its credit support provider, or a party that has entered into a financially unfavorable merger or acquisition transaction by a particular institution is the affected party, and the other party shall have the right to terminate all transactions under this Agreement. This is because the merge affects all transactions, not just some of them. Some market participants have modified this termination event to define "materially weaker" more objectively in the annex, such as a downgrade by a credit rating agency, a minimum credit rating, or a complete loss of credit rating by the merged party.
(5) The scope of a merger event may include: 1) a combination, merger or merger, transfer of substantial assets, reorganization, reorganization, etc., 2) direct or indirect acquisition of equity in the election of a majority of the board of directors of one party, or other beneficial rights that can exercise control over one party, and 3) a significant change in the capital structure of one party through the issuance of bonds, preferred shares, guarantees or other forms of ownership (such as the issuance of convertible bonds after a leveraged buyout to change the capital structure of the original parties). Taking into account the "credit events arising from merger" mentioned in clause 5(b)(v) as outlined, the parties may expand this section in the annex as the case may be. It is important to emphasize that the combined entity is significantly reduced in financial strength or creditworthiness, and if its creditworthiness is improved as a result of the merger, there will be no credit event resulting from the merger.
条款标题：(vi) Additional Termination Event.其他终止事件
Consider: A new Section 5(b)(vi) has been added to this Agreement so that the parties may designate other termination events (e.g., change in ownership, material adverse change, failure to maintain the right to appoint directors, failure to appoint, unusual events, market disruption events, etc.) in Part 1(g) of the Appendix or any confirmation document. In addition, for product customers, certain material adverse events and abnormal events that occur at the product manager and product level may also be agreed in the "other termination events"), as well as any affected party or affected parties of such other termination events. Assuming that other termination events occur, all transactions are affected and non-affected parties have the right to terminate them. Many other terminations are credit-related (e.g., a rating agency downgrades a party's outstanding long-term bonds below the lowest rating, or a credit rating agency cancels the rating) and therefore affects the entire contractual relationship between the parties, not just a particular type of transaction.
条款标题：5(c)Hierarchy of Events.事件的等级
Consider: (1) If any event or circumstance constitutes an illegal event or force majeure event and also constitutes a "failure to pay or deliver", 5(a)(iii) "credit backed default", 5(a)(ii) "breach of agreement" under clause 5(a)(i) of the Master Agreement, then that event will still be deemed an illegal event or force majeure event. The key point is that as long as the waiting period continues, the unlawful act or force majeure event does not give rise to a failure to pay or deliver, a breach of the agreement or an event of default on credit support, as long as it relates to the failure to pay, deliver or perform any material term of the agreement or credit support document. As a result, illegal acts and force majeure events take precedence over these events of default during the waiting period, but not in other cases.
(2) In addition to the foregoing 1 above, if an unlawful act or force majeure event also constitutes another event of default (other than "failure to pay or deliver" under clause 5(a)(i), 5(a)(iii) "credit-backed default", 5(a)(ii) "breach of agreement"), it shall be deemed to be an event of default and not as an illegal or force majeure event, as it may terminate the transaction earlier. For example, if the same counterparty's event of default on bankruptcy coincides with illegal acts, the non-defaulting party may terminate all transactions based on the event of default on the basis of the event of bankruptcy default when the market is favourable without the delay of the waiting period. This provision stems from the 1998 Russian debt crisis, when, after the event of a bankruptcy default and illegal acts, market participants were not in favor of treating the above situation as illegal.
(3) In addition to paragraph 1 above, in any other event or circumstance that constitutes an illegal event or force majeure event and also constitutes Section 5(b)(v) "Credit Event as a result of merger" or Section 5(b)(vi) "Other Termination Event" of the Master Agreement, it shall be deemed to constitute such Termination Event and not as constituting an Illegal Event or Force Majeure Event.
(4) A similar principle applies here, if an event occurs that constitutes both an unlawful act and a force majeure event (waiting period of 8 local working days), the event will constitute an illegal event and not a force majeure event, as the waiting period for an illegal event is a shorter waiting period of 3 local working days.
条款标题：(d) Deferral of Payments and Deliveries During Waiting Period.等待期间的迟延付款及交付
Think: This clause deals with delays in payment or delivery in the event of an unlawful act or force majeure event that persists. The clause provides that such payment or delivery is due only when the following occurs:
1) the 1st local business day or the 1st local delivery day after the end of the appropriate waiting period for an illegal or force majeure event;
2) If the event ceases on the same day before the end of the waiting period, or if it is not a local business day or local delivery day, on the next local business day or local delivery day.
条款标题：(e) Inability of Head or Home Office to Perform Obligations of Branch.总部或总办事处不能履行分支的义务
Reflection: This complex provision deals both with the inability of a branch office to pay or perform after an unlawful act or force majeure event and with the same situation at the head office or head office of an unaffected party in the event of a recourse against its head office or head office as a result of the application of Article 10(a) of this Agreement. In the foregoing, if there is an unlawful or force majeure event at both the said office and the affected party's head office or head office, the failure to pay or perform will not constitute an event of default under Section 5(a)(i) "Failure to Pay or Deliver" or Section 5(a)(iii)(1) "Credit Backed Default".
Author: Liu Yan, the executive director of product design in the OTC derivatives department of Guotai Junan Risk Management Co., Ltd., and intern Wang Lishu assisted in the collection and translation of reference materials for this article.
Annotation:
[1] 篇幅所限，本文只对主协议重点条款进行分析思考；为方便理解，请对照ISDA发布的Chinese Translation of the 2002 ISDA Master Agreement-For Educational Purposes Only - Simplified Chinese进行阅读，该文版权属于ISDA。
Disclaimer: The information in this article is for investor education purposes only and does not constitute any investment advice to investors, and investors should not substitute their independent judgment or make decisions based solely on such information. The information in this article is intended to be accurate and reliable, but the accuracy or completeness of such information is not guaranteed, and no liability is accepted for any loss or damage that may arise from the use of such information.