Overnight, the International Swaps and Derivatives Association, Inc. (ISDA) published a new protocol called the "ISDA Illegality/Force Majeure Protocol" (Protocol). The Protocol is designed to enable parties to amend their 1992 ISDA Master Agreements to bring them into line with the illegality/force majeure provisions in the 2002 ISDA Master Agreement.
Why publish the Protocol?
ISDA has been working with its counsel and a small discussion group of members to understand the implications of an exit by a member state from the Eurozone for the over-the-counter (OTC) derivatives industry. Although ISDA has stated that it considers the exit of a Eurozone member to be unlikely, it believes that it would be prudent to plan for such an outcome and to this end has been considering the steps that it could take to help OTC derivatives market participants prepare for such an event.
ISDA's publication of the Protocol is the latest step in this contingency planning process and is intended to address ISDA's specific concern that an exit by a member state from the Eurozone could lead to the imposition of capital (including exchange) controls, which may render illegal or impossible the fulfilment of cross-border payment or delivery obligations in respect of OTC derivatives contracts.
Should this eventuate, parties who have the benefit of the Protocol will be in a better position to address the consequences of payment or delivery obligations being rendered impossible as a result of a force majeure event (the standard 1992 ISDA Master Agreement is silent on the consequences of this). In addition, the Illegality Termination Event in the 2002 ISDA Master Agreement is generally regarded as an improvement on the corresponding provisions of the 1992 ISDA Master Agreement because it:
clarifies that any transaction-specific fallback provisions should take effect before the illegality provision in the Master Agreement applies;
removes the obligation to attempt to transfer transactions before relying on the Illegality Termination Event; and
provides for the deferral of payments and deliveries during a waiting period before the provision takes effect.
How will the Protocol work?
Market participants can sign up to the Protocol by completing an adherence letter in the form set out in the Protocol and delivering it as an email attachment to ISDAIFMprotocol@isda.org. Where both parties to a 1992 ISDA Master Agreement have submitted adherence letters to ISDA, each 1992 ISDA Master Agreement between them will be automatically amended in accordance with the terms of the Protocol.
At present there is no cut-off date for delivery of adherence letters to ISDA, although ISDA has reserved the right to specify a cut-off date on 30 days' notice.
What other steps is ISDA taking?
On 25 May 2012, ISDA published an update on its Eurozone contingency planning. The publication outlines its current thinking on the uncertainty associated with the current situation in the Eurozone and the risks that could eventuate, including the risk that certain payment obligations or reference assets could be redenominated following the exit of a Eurozone member. In light of these risks, ISDA recommends that parties to OTC derivatives contracts review their agreements to identify any potential issues that could arise as a result of a currency redenomination. To assist with such reviews, ISDA has obtained advice on potential issues on an asset-class basis, which are available on its members-only Eurozone contingency planning page (log-in required).
ISDA is also planning its post-event response, including:
industry-wide conference calls to identify issues requiring immediate decisions and action and to reach consensus on those issues
arranging for counsel in the Eurozone member states that are more “at risk” of a Eurozone exit to be on standby to provide urgent advice on any local laws implementing a currency redenomination.
ISDA plans to co-ordinate its responses with trade associations representing other sectors of the financial markets in order to avoid overlap and ensure consistency of approach.
Implications for Australia
We expect that participants in the Australian derivatives industry will welcome the Protocol as a means to supplement their own Eurozone contingency planning measures.
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