Set the Controls… : ISDA Publishes the 2013 Account Control Agreement
The International Swaps and Derivatives Association, Inc. (ISDA) published its ISDA 2013 Account Control Agreement (the ACA). The ACA has been developed by a working group of buy-side, sell-side and custodian firms and is designed to give market participants a framework agreement for documenting their arrangements for the segregation of Independent Amounts relating to uncleared derivative transactions.
Since the collapse of Lehman Brothers in 2008, many market participants have become increasingly aware of the risks associated with the provision of excess collateral. Even since before the concept of mandatory segregation of collateral was first considered under Dodd-Frank and EMIR, the Derivatives & Structured Finance group at Fieldfisher has worked with several buy-side, sell-side and custodian firms in establishing and negotiating their initial margin and haircut segregation arrangements. Those negotiations are often highly complex, with each party's interests appearing to be incompatible with those of the other parties.
The ACA is a welcome initiative. It allows parties to focus their attention on the primary negotiating points and identifies some potential solutions to the difficulties that parties face in reaching a satisfactory conclusion in those negotiations. This alerter looks at some of the key issues that parties should consider before using the ACA or any other account control agreement.
Negotiation of principal terms
Like much of ISDA's derivatives documentation, the ACA is a framework agreement that enables the parties to specify, in the Annex, the terms that they have agreed bilaterally. Unlike those other documents, however, the main body of the ACA does not contain many provisions relating to its primary purpose, namely the circumstances in which the collateral provider or the collateral taker may give instructions to the custodian for the release of the collateral. The fact that these provisions are located in the Annex and – despite months of careful consideration at an industry-wide level – are structured as suggested elections rather than a standard approach, reflects the inherent difficulty in aligning the interests of the collateral provider, the collateral taker and the custodian.
The issues that require negotiation include:
(a) whether a notice of exclusive control or a pledgor access notice can be given in one stage in respect of the entire collateral pool, or whether the instructing party may first only access the amount that it estimates is likely to be required;
(b) whether a waiting period applies before the collateral is released;
(c) whether the non-instructing party has any dispute right in respect of a notice of exclusive control or a pledgor access notice given by the other party;
(d) whether any such dispute has the effect of a veto, and whether there are any events that are not capable of being disputed or vetoed ("Indisputable Events");
(e) how to address the possibility of conflicting instructions by the pledgor and the secured party;
(f) whether the custodian should have a security interest and rights of set off in relation to the collateral, and if so, the relative priorities between the custodian and the secured party;
(g) the extent of indemnities in favour of the custodian and how to allocate the burden of these between the secured party and the pledgor; and
(h) the terms on which the custodian may terminate the ACA, and how the collateral is distributed in those circumstances.
Parties should therefore consider in each case whether the options in the Annex are appropriate for their requirements, or whether they require further refinement (or replacement) to suit the parties' commercial needs. Parties will of course need to ensure that the provisions of their ACA correspond to, or are reflected in, the document that governs the provision of the collateral and the secured party's security interest in it.
For example, the ability of the non-instructing party to dispute any notice of exclusive control or pledgor access notice within a specified window, perhaps together with the option for this dispute right to expire unless formal legal proceedings have been commenced within a second window, may be a useful compromise for parties who wish to have dispute rights which permit a valid dispute to be raised while preventing the disputing party from vexatiously frustrating the valid release or enforcement of collateral. Parties should, of course, ensure that these arrangements are consistent with any broader "control" requirements for purposes of security characterisation, perfection and enforceability.
Using the ACA
The ACA has been developed primarily for use in the US markets, in particular in connection with collateral pledged under a New York law Credit Support Annex. As such, it is intended to satisfy the control requirements in the Uniform Commercial Code (UCC). However, it is expected that parties in the European markets may wish either to adapt it for use with other collateral arrangements (such as an English law Credit Support Deed) or to include equivalent provisions in their bespoke account control arrangements. Similarly, parties may wish to adapt the ACA for use with other excess collateral arrangements, such as haircuts in repos and stocklending arrangements.
Parties wishing to do so should carefully consider any differences in the requirements to perfect security interests as between a New York law pledge and a European security interest, in particular any differences in the concept of "control" for the purposes of the UCC and the European Financial Collateral Directive, as implemented in applicable national law. Parties should also consider the implications of using the ACA (or any of its provisions) where the collateral being segregated is limited to excess collateral rather than the entire pool of collateral. Finally, parties should also ensure that the arrangement closely tracks the underlying document under which the excess collateral is provided (whether an ISDA Credit Support Deed or a bespoke security agreement relating to a Global Master Repurchase Agreement or Global Master Securities Lending Agreement).
The ACA will undoubtedly be a useful reference point for parties considering establishing account control arrangements relating to the segregation of collateral, in particular excess collateral. As noted above, it is certainly a welcome initiative that will enable industry participants to focus their attention on the key issues, as well as identifying potential solutions to the difficulties they face in their negotiations. However, as with any industry standard document, the publication by ISDA of the ACA should not be seen as a substitute for careful consideration of the issues relating to account control arrangements, and parties should continue to ensure that their arrangements are suitably robust in addressing their legal, commercial and credit requirements.
If you wish to discuss the ACA or any other account control arrangement, please contact any member of Fieldfisher's Derivatives and Structured Finance group.