The long-awaited amendment to Section 2(a)(iii) of the ISDA Master Agreement has finally been published by ISDA in the form of a bilateral amendment agreement1. The final wording is much advanced from the original draft and addresses the concerns we identified with that wording in our earlier briefing paper. ISDA have also published an explanatory memorandum.
The substance of the amendment is essentially a "put up or shut up" provision of the type we have espoused for some time now. Helpfully, it also now addresses Potential Events of Default, allowing the party affected to elevate this to Event of Default status for the purposes of operating the provision. The only open point for the parties to agree is the waiting period which is to be applied. The published wording tentatively suggests 90 days, which is the maximum period that the FCA have said they would expect to see.
Having pushed the industry towards the application of a time limit to section 2(a)(iii), it will be interesting to see whether any pressures are applied by regulators to firms to implement the change. The ultimate pressure that could be applied, of course, would be to take the position that netting will not be recognised as risk reducing for regulatory capital purposes unless Section 2(a)(iii) is disapplied or restricted, although whether regulators go that far remains to be seen.
It should be borne in mind that other standard netting agreements (such as the GMRA) as well as many prime brokerage and futures terms contain provisions similar to Section 2(a)(iii). There is no reason why the same or a similar approach should not be considered or required for those.
As noted in the memorandum accompanying the proposed wording, there are also Section 2(a)(iii) equivalents in the New York Law CSA and English law CSD which could also be amended in a similar way, although those provisions deal with slightly different issues.
Finally, parties seeking to use the amendments should think about whether the inclusion of a time-limit in Section 2(a)(iii) might adversely affect the conclusions in any netting opinion on which they are relying. One assumes that, in time, ISDA will ask counsel in their annual netting opinion updates to confirm that the amendments would not affect their conclusions.
If you have any questions about this issue or its application or effect, please do not hesitate to contact us.
1. Following the Australian case of Enron v TXU in 2007 there were suggestions that Section 2(a)(iii) might be a "walk-away" provision. Subsequently the UK and US regulators looked at the issue and it was referred to the Financial Markets Law Commission. The outcome was inconclusive. However, in December 2009, the UK Treasury published a recommendation that the industry should address the issues arising from Section 2(a)(iii) following the Lehman bankruptcy. A "walk-away" provision is a provision which permits a non-defaulting counterparty to make only limited payments, or no payment at all, to the estate of a defaulter, even if the defaulter is a net creditor. Netting agreements which contain walk-away provisions are not afforded recognition as risk reducing for regulatory capital purposes under the Basel Capital Accords.