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6(a) Right to Terminate Following Event of Default. If at any time an Event of Default with respect to a party (the “Defaulting Party”) has occurred and is then continuing, the other party (the “Non-defaulting Party”) may, by not more than 20 days’ notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions. If, however, “Automatic Early Termination” is specified in the Schedule as applying to a party, then an Early Termination Date in respect of all outstanding Transactions will occur immediately upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(1), (3), (5), (6) or, to the extent analogous thereto, (8), (Bankruptcy) and as of the time immediately preceding the institution of the relevant proceeding or the presentation of the relevant petition upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(4) or, to the extent analogous thereto, (8).
| Subject | 2002 (wikitext) | 1992 (wikitext) | 1987 (wikitext) |
|---|---|---|---|
| Preamble | Pre | Pre | Pre |
| Interpretation | 1 | 1 | 1 |
| Obligns/Payment | 2 | 2 | 2 |
| Representations | 3 | 3 | 3 |
| Agreements | 4 | 4 | 4 |
| EODs & Term Events | 5 Events of Default: FTPD • Breach • CSD • Misrep • DUST • Cross Default • Bankruptcy • MWA Termination Events: Illegality • FM • Tax Event • TEUM • CEUM • ATE | 5 Events of Default: FTPD • Breach • CSD • Misrep • DUST • Cross Default • Bankruptcy • MWA Termination Events: Illegality • Tax Event • TEUM • CEUM • ATE | 5 Events of Default: FTPD • Breach • CSD • Misrep • DUSS • Cross Default • Bankruptcy • MWA Termination Events: Illegality • Tax Event • TEUM • CEUM |
| Early Termination | 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations; Payment Date • Payments on ET • Set-off | 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations • Payments on ET • Set-off | 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations • Payments on ET |
| Transfer | 7 | 7 | 7 |
| Contractual Currency | 8 | 8 | 8 |
| Miscellaneous | 9 | 9 | 9 |
| Offices; Multibranch Parties | 10 | 10 | 10 |
| Expenses | 11 | 11 | 11 |
| Notices | 12 | 12 | 12 |
| Governing Law | 13 | 13 | 13 |
| Definitions | 14 | 14 | 14 |
| Schedule | Schedule | Schedule | Schedule |
| Termination Provisions | Part 1 | Part 1 | Part 1 |
| Tax Representations | Part 2 | Part 2 | Part 2 |
| Documents for Delivery | Part 3 | Part 3 | Part 3 |
| Miscellaneous | Part 4 | Part 4 | Part 4 |
| Other Provisions | Part 5 | Part 5 | Part 5 |
Resources and Navigation
Index: Click ᐅ to expand:The ISDA’s Automatic Early Termination provision — colloquially “AET”, but not to be confused with “ATE” or “ETA” — is triggered — sorry for the passive, but there is no way around it — by certain Bankruptcy Events of Default. Not all of them, though. If it is triggered, AET deems all Transactions under the ISDA Master Agreement to be — or, in the case of a formal insolvency petition, to have just been — immediately terminated. In that last case, some creative warping of lexophysical spacetime is required, which we will discuss at some length and with no small amount of wistful pedantry, in the premium section.
Automatic Early Termination first appeared as a named term in the 1992 ISDA. It did feature, uncredited, in the 1987 ISDA, though in this larval stage it was a blunt instrument indeed: it was mandatory and applied against every party in the case of any Bankruptcy event, regardless of the risk that party’s insolvency regime would jeopardise the ISDA Master Agreement’s carefully machined close-out and netting mechanics. This was unquestionably overkill, and yet another reason to steer clear of the 1987 ISDA.
By the 1992 ISDA, the ’squad had made some key adjustments:
Thereafter they did not change the language of 6(a) between the 1992 ISDA and the 2002 ISDA.
HAL 9000 : Just a moment — just a moment — I just picked up a fault in the AET-87 Unit.
Frank Poole : What is it?
HAL 9000 : It’s a device for optimising regulatory capital, but that’s not important right now.
David Bowman : What’s the problem, HAL?
HAL 9000 : It’s going to go one hundred per cent. failure, within 72 hours.
Poole : Surely, you can’t be serious?
HAL 9000 : I am serious. And don’t call me “Shirley”.
Bowman : (sticking to the script) I don’t know what you’re talking about, HAL?
Cue musical introduction
HAL9000 : Well, I’ll tell you.
Chorus : He’s going to tell!
He’s going to tell!
He’s going to tell!
He’s going to tell! —
Poole : Stop that! Stop that! No singing!
Carries on for three hours in this vein
—Monty Python and the Magnetic Anomaly from Airplane!Automatic Early Termination is an odd and misunderstood concept. It sits buried at the back end of Section 6(a) (Right to Terminate Following Event of Default). In essence it provides that where a party to whom AET applies suffers an in-scope Bankruptcy event, all outstanding Transactions are instantly terminated, without the need for any action by the Non-Defaulting Party.
This inverts the normal order of things under the ISDA Master Agreement wherein the Non-Defaulting Party generally has the right, but not the obligation, to call an Event of Default. Being automatic, therefore AET even obliterates the Non-Defaulting Party’s ability to waive this event, since by the time it is in a position to do so, the event has already happened.
(Could a NDP pre-waive in anticipation? See “anticipatory waiver?” in the premium section if that is the sort of thing that keeps you up at night.)
JC’s general view is that Automatic Early Termination is a bad solution to an unlikely problem, but since it is intractably embedded in every ISDA on the planet, after thirty-five years of folly, we are pretty much stuck with it.
Others — for example the learned author of Cluley on Close-Outs — have a different view. But, look: JC has to depart ways with the cool crowd every now and then, just to maintain his membership with the Worshipful Company of Contrarians. This is one of those times.
Triago : Herewith, hereinafter and hereinbefore-confirmed:
A custom aperture. Wall-inlaid,
Well-glazed and fringed by lintel stone.
A device to shed upon us light!
Regolamento : Oh, a window?
Triago : Good heavens, No! Not that!
(Whispering) There are ways and means of saying ’t, ser —
Prithee, gird thy vocabulary about with care
Lest th’Exchequer’s like for “levies upon transparency”
Untimely drains th’excess from our meagre pocketbooks —
Catcheth thou the drift?
Regolamento : It is not a window, then? These sound like solid facts?
Nuncle : ’Tis not so much a window
As a means of dodging tax.
—Büchstein, Talentdämmerung
Automatic Early Termination is as much to do with managing regulatory capital — in particular, vouching safe close-out netting — as it is about substantive credit risk mitigation.
Banks — those who calculate regulatory capital in banks, or are obliged to read netting opinions on their behalf at any rate, care a lot about it.
Other market counterparties, perhaps less so. Given that its potential effect is likely to be “iatrogenic” — worse than the risk it addresses — a non-bank counterparty could be forgiven for being a little blasé. [1]
Where a Defaulting Party’s insolvency regime allows its administrator to suspend its contractual terms or cherry-pick which of its Transactions to honour, it would help the Non-Defaulting Party if the ISDA were to automatically terminate before the administrator had a chance to do any such thing. To be safe, termination should happen at the exact moment — or even an infinitesimal moment before — that insolvency regime kicks in.
There are two things such a suspension could affect:
A swap counterparty to a portfolio of swap transactions scheduled to mature over the next five years may have no present obligation to pay any cash under those Transactions even if, from a mark-to-market perspective, the net present value of that portfolio is significantly negative. Who knows? Things may come right.
AET It was introduced in the 1987 ISDA, but was not labelled “Automatic Early Termination” in that agreement, possibly because it was not conceived as an optional election to be used with caution where needed: it just sat there and applied across the board.
AET is thus only triggered by certain events under the Bankruptcy event of default — formal bankruptcy procedures — and not by economic events that tend to indicate insolvency (such as an inability to pay debts as they fall due, technical insolvency or a creditor’s mere exercise of default rights or enforcement of security. Though, interestingly, those events (captured in limbs (2) and (7) of the Bankruptcy definition) did trigger automatic early termination in the 1987 ISDA. This is just one more reason not to use that edition, if there are any Burmese Junglers out there looking for one.
AET does not apply to other Events of Default.
Though the 1987 ISDA triggered automatic termination upon any type of Bankruptcy event for any counterparty in any jurisdiction, it has since turned out that the mischief against which AET guards does not really arise in most jurisdictions: only those a history of Teutonic jurisprudence.
In those (e.g., Germany, Austria, Switzerland and Japan) immediately upon commencement of formal bankruptcy proceedings a bankruptcy administrator would be entitled “cherry-pick” those Transactions it wishes to honour (typically, those that are in-the-money to the Defaulting Party whose estate it is administering) and those it wished would just conveniently vanish from the financial record (namely those where the Defaulting Party is out-of-the-money).
Since the whole point of the Single Agreement and the close-out netting concept is to get to a market exposure as close as possible to zero before launching any recovery actions, this kind of cherry-picking would completely demolish the entire capital theory on which the ISDA Master Agreement is founded. Hence, Automatic Early Termination!
In any case, since the 1992 ISDA AET has been an election that you toggle on or off for each counterparty in Part 1 of the Schedule.
AET is only really useful:
(1) to a regulated financial institution, which
(2) would incur a capital charge if it doesn’t have a netting opinion, and
(3) where it wouldn’t get that netting opinion for a particular counterparty without AET being switched on in its ISDA Master Agreement.
There are only a few counterparty types where these conditions prevail: the German and Swiss corporates mentioned above, for example. There may be others, but not many, because AET is a good-old-days, regulators-really-are-dopey-if-they-fall-for-this kind of tactic. It only really survives these days because it is so part of the furniture no-one has the chutzpah to question it, despite the trail of destruction and confusion it has left across the commercial courts of the US an the UK.
I mean, really? Deeming your ISDA to have magically terminated, without anyone’s knowledge or action, the instant before that termination would become problematic as a result of your insolvency? Come on. Is any sophisticated insolvency regime going to buy that kind of magical thinking? (No slight meant on Germany or Switzerland here: the “Teutonic” AET does not deliver netting where unequivocally it would otherwise be forbidden, but rather buttresses residual doubt about the effectiveness of netting during insolvency as a result of looseness in insolvency regulations that aren’t categorical that you can net. The view is generally it should be okay in insolvency, but there are just some freaky discretions that may make life awkward if used maliciously. This is not legal advice.)
Master trading agreements are unusual in that upon an Event of Default, there is no guarantee a given portfolio of Transactions will be in-the-money to the Non-Defaulting Party.
The last thing an NDP will want to do is accelerate Transactions under ISDA if that means it winds up realising mark-to-market losses. Indeed, the “flawed asset” provisions of the ISDA Master Agreement are designed precisely to allow a Non-Defaulting Party to suspend its own performance — therefore not make its position any worse — without crystallising its Transaction exposures.
Having Transactions automatically accelerate is undesirable: one would only choose that if the alternative was catastrophically worse.
In the minds of those who framed the early ISDAs, mendacious application of discretions by foreign bankruptcy administrators was just such a catastrophic worseness.
But —time having passed, water flowed under the bridge and tempers mellowed with age and wisdom — JC wonders whether there are not better things the world’s risk officers to be fretting about instead of the capital implications of general rules of governance that apply to local corporations.
There is an extended rant on the close-out netting page.
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