Documentation for Derivatives 2002 Master Agreement Supplement

Documentation for Derivatives
2002 Master Agreement Supplement
PREFACE
This Supplement to the fourth edition of Documentation for Derivatives deals
with a single subject, the ISDA 2002 Master Agreement form. It is in the true sense a
supplement to that book in that this Supplement does not seek to replace the fourth edition’s
commentary on other standardized documents for over-the-counter (OTC) derivatives
or other financial products or our discussion there of many other matters, including
legal issues relating to OTC derivatives, credit support and related documentation, the
risks that two parties may be exposed to when they engage in bilateral dealings under
multiple agreements and standard market frameworks for managing those risks. 1
As indicated in the User’s Guide to the ISDA 2002 Master Agreement 2 and discussed
in the Introduction to this Supplement, the 2002 Master Agreement form is the
outgrowth of a strategic documentation review begun by ISDA in 1999 to analyze how
the most widely used standardized document for over-the-counter (OTC) derivatives—
the ISDA 1992 Master Agreement (Multicurrency–Cross Border) form—might be modified
to address concerns that began to arise in the late 1980s in four principal areas:
• Difficulties and disputes involving Loss and Market Quotation—the
established ISDA approaches for determining an early termination, or
close-out, settlement payment, particularly in times of market stress
and for transactions with relatively illiquid markets, even absent conditions
of stress;
• the framework (which in practice had proved flawed and excessively
long) for dealing with changes in law after the parties have agreed on a
1 Parts 1 through 4 of the fourth edition of Documentation for Derivatives include eight chapters on legal
issues in derivatives documentation, analyses of the structure of the ISDA master agreement forms and of
product-specific booklets of definitions published by ISDA and others, descriptions of the principal derivative
products covered by those definitions and sample confirmations prepared using them. The sample annotated
agreements and schedules there illustrate the use of ISDA’s 1992 forms and the ways in which they
may be, and often are, customized to reflect the concerns and policies of market participants. Part 5 discusses
the use of credit support with OTC derivatives and ISDA’s standardized sets of credit support terms.
It includes an annotated sample NY CSA, among other illustrative documents. Part 6 discusses the risks that
may arise when the parties’ mutual dealings in financial products are governed by multiple agreements. It
analyzes approaches to the management of these risks published by ISDA and others (e.g., ISDA set-off and
contract or default bridge provisions) and includes an annotated sample Cross-Product Master Agreement
prepared using the CPMA form published in 2000 by TBMA with other sponsoring groups, including ISDA.
The original CPMA is designed to manage risks involving dealings between the same two parties under multiple
agreements. Since the release of the fourth edition of Documentation for Derivatives, TBMA and other
sponsors have published an alternative Cross-Product Master Agreement (Cross-Affiliate Version 2), known
as CPMA 2, as a standardized tool to assist market participants in managing these risks in cases involving a
single defaulting party and multiple, affiliated, nondefaulting parties. The Table of Abbreviations, supra p.
ix, lists the abbreviated names that are used in this Supplement to refer to various works and indicates the
names of their publishers and, if applicable, where they can be found on the Internet.
2 At i.
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Documentation for Derivatives 2002 Master Agreement Supplement
transaction, if the changes render the performance bargained for by the
parties illegal;
• the lack of a framework for dealing with cases in which that performance
is prevented or rendered impossible or impracticable by circumstances
(such as governmental action, civil strife, natural disaster and
acts of terrorism) not caused by and beyond the control of a party or a
provider of credit support for its obligations; and
• for a party that uses multiple agreements to document financial product
dealings with a single counterparty, the substantive and timing differences
in those agreements relating to grounds for close-out and the
risks that these differences, and the use of multiple agreements more
generally, may create. 3
The strategic documentation initiative also addressed concerns relating to ISDA’s
standard credit support documents—the Credit Support Annex (Bilateral Form) published
by ISDA in 1994 for use with master agreements governed by New York law (the “NY
CSA”) and the form of Credit Support Annex published in 1995 for use in bilateral arrangements
under English law involving credit support through transfers of title (the “Title
Transfer CSA”). In this area, ISDA’s principal aims were to adopt terminology more
nearly consistent with that used by collateral practitioners, to refine and tighten provisions
on the delivery and release of collateral and the resolution of related disputes, to
provide an alternative framework for the lock-up of collateral throughout the term of a
transaction, where that practice is used in the particular market (e.g., equity derivatives)
and to facilitate the cross-collateralization of the parties’ exposure to each other under
their multiple dealing documents in a framework that calculates that exposure on a net
basis. In 2001, ISDA addressed many of these issues by publishing amendments to its
1992 master agreement forms and the NY CSA and Title Transfer CSA, 4 as well as the
Margin Provisions and the 2001 ISDA Cross-Agreement Bridge. 5
As ISDA finalized these efforts, we incorporated them into the discussion and
sample annotated documents that we were preparing for the fourth edition of Documentation
for Derivatives. However, lack of consensus on some features of the 2001 ISDA
Amendments soon led to a reassessment of that project. An important focus of the reassessment
was the substitution in the 2001 ISDA Amendments of an approach called “Replacement
Value” for the 1992 ISDA forms’ choices of Loss and Market Quotation as the
possible means of calculating close-out settlement payments. In the course of that exercise,
ISDA announced its intention to produce—rather than another round of amendment
forms—a new master agreement that would address the strategic documentation initiative
3 See infra note 12 on the main risk.
4 See Documentation for Derivatives 1057 for discussion of these and other approaches to credit support
widely used in the derivatives market, as well as the key issues they raise and annotated sample credit support
documents prepared using the NY CSA (including an illustration of how that ISDA form, which assumes
that each of the parties may be required to post support, may be modified so that only one party will
be required to do so). The sample documents also include provisions on lock-up of collateral and, for those
who cannot or are not inclined to post collateral, recouponing provisions.
5 See Documentation for Derivatives 1281.
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Preface
xv
issues listed above, incorporate the results of the reassessment and make some structural
and stylistic improvements to the 1992 Master Agreement (Multicurrency–Cross Border)
form while largely preserving the remainder of that form as the model for the new agreement.
We decided to release the fourth edition in July 2002 rather than to wait for publication
of the new ISDA agreement, with the intention of preparing this separate treatment
of the new form when it became available.
The new form was published as the ISDA 2002 Master Agreement form in January
2003. Following this Preface, the Introduction to this Supplement summarizes the
principal differences between the new form and its 1992 predecessors. The remainder of
this Supplement is set out in two parts. Part 1 of this Supplement consists of an annotated
sample document prepared using the ISDA 2002 Master Agreement form. The annotations
provide greater detail on the differences summarized in the Introduction and explain
how the provisions of the 2002 Master Agreement form operate with each other. The annotations
also refer throughout to the fourth edition of Documentation for Derivatives.
The 2002 Master Agreement form preserves substantial parts of ISDA’s 1992 Master
Agreement (Multicurrency—Cross Border) form, and Part 3 of the fourth edition includes
a sample master agreement prepared using that form, with annotations that may be relevant
to users of the 2002 Master Agreement form as to the shared provisions of the 1992
and 2002 forms.
Part 2 of this Supplement includes samples of three forms of bilateral amendments
that ISDA has published for use by those who are not inclined, at least for the present,
to adopt the 2002 Master Agreement form but who wish to amend their existing
agreements and any related NY CSA or Title Transfer CSA to adopt the 2002 Master
Agreement form approach, called “Close-out Amount,” to the calculation of early termination
settlement payments. 6 Part 2 also includes an annotated version of the ISDA 2002
Master Agreement Protocol, which was designed to facilitate amendments to agreements
prepared using these and other ISDA publications identified in 18 Annexes to the Protocol
by any two parties who adhere to the same Protocol Annexes, once those parties enter
into an agreement based on the 2002 Master Agreement form. As a general matter, the
amendments implemented in the Protocol Annexes are limited to changes to the identified
earlier ISDA documents—standardized credit support terms and product-specific booklets
of definitions 7 —that are necessary to drop terminology from the 1992 Master
Agreement (Multicurrency—Cross Border) form if that terminology is not used in the
2002 Master Agreement form, and to make appropriate additions of terminology used in
the 2002 Master Agreement form but not in its 1992 predecessors. 8
6 See infra p. 7 on the concerns about documentation basis risk that are behind the publication of the first
of these amendments, the 2003 ISDA Close-out Amount Amendment Form set out in Part 2 to this Supplement,
infra p. 115.
7 See Documentation for Derivatives 369 on the various product-specific sets of definitions and how
they are usually incorporated by reference into a master agreement prepared using an ISDA form either
through the confirmation for a specific transaction or in the master agreement schedule. Market participants
should note that, since the publication of Documentation for Derivatives, ISDA has published new editions
of some of the booklets discussed there.
8 Thus, as illustrated infra p. 133, the amendments in the Protocol Annexes are somewhat prosaic and
require little in the way of explanation. Typically, they replace references to the earlier ISDA master agreement
forms with references to the 2002 Master Agreement form, they eliminate references to the Loss and
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Documentation for Derivatives 2002 Master Agreement Supplement
In this Supplement, as in provisions of Documentation for Derivatives referred to
here, we have expressed views that we have formed as a result of our practice with OTC
derivatives, after taking into account the guidance notes or user’s guides published by
ISDA and other associations or groups that have produced, or participated in the production,
of the standardized agreements and other terms on which we comment, as well as
the ever-growing literature on the subject. They are our views and should not be attributed
to others, including our respective law firms or their clients. We have advised, and
our law firms regularly represent, a number of the entities involved in some of the disputes
described in Documentation for Derivatives and our other writings. In some cases,
we or our firms have acted as counsel or filed amicus curiae briefs in connection with
those disputes.
The views expressed in this Supplement and in Documentation for Derivatives
should not be thought of as legal advice. The sample agreements and confirmations are
merely illustrations involving hypothetical parties and circumstances, and they should not
be used for actual agreements or transactions. The documentation for a transaction must
be carefully tailored to address the legal issues affecting the particular parties and the
characteristics of the transaction. The documentation must take into account the law as it
stands at the time of the transaction in the relevant jurisdictions and the institutional policies
of the parties and the business goals the parties are seeking to serve by engaging in
the transaction.
We wish to thank the International Swaps and Derivatives Association, Inc. for
permitting us to include some of their publications as the basis for the annotated documents
included in this Supplement. We also wish to thank the many people, both colleagues
and clients, who have helped and encouraged us over the years in our practice
and writings.
Anthony C. Gooch and Linda B. Klein
January 15, 2004
Market Quotation approaches in the 1992 master agreement forms and replace them with references to the
Close-out Amount concept introduced in the 2002 Master Agreement form, and they take into account
changes involving Illegality and Force Majeure Events, as well as to the confirmation process, as included in
the 2002 Master Agreement form. Rarely do they otherwise seek to amend the particular standardized terms
covered by an Annex, although there is an occasional adoption of terminology from the 2000 ISDA Definitions
in place of terminology from the 1991 ISDA Definitions.
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