ISDA Master Agreement - Lessons Learned from the 2008 Financial Crisis

16 March 2023

Not only banks and insurance companies, but also many other companies and pension funds conclude derivative transactions to hedge financial risks. Often this is done on the basis of an ISDA Master Agreement. What should be done if the counterparty is threatened or even affected by insolvency proceedings or another event of default? What can be done to prepare for this emergency?

ISDA Master Agreement

The ISDA Master Agreement is a framework agreement that covers all derivative transactions concluded thereunder. Each derivative transaction is documented by so-called confirmations. If an Event of Default occurs, the ISDA Master Agreement contains instructions on how to proceed, which give the non-defaulting party relatively great leeway in some respects. The procedure must be carefully planned, as its appropriateness can become a point of contention afterwards.

Automatic termination in case of bankruptcy

If a Swiss counterparty is involved, many contracting parties have agreed on an automatic termination in the Schedule to the ISDA Master Agreement. Whether this is the case must be checked in each individual case. If the Schedule to the ISDA Master Agreement provides for automatic termination, the ISDA Master Agreement and thus all derivative transactions will often be terminated automatically. If the Schedule to the ISDA Master Agreement does not provide for an automatic termination, there is a right of termination.

Close-out in case of termination

The basic principle of the ISDA Master Agreement is that, in the event of termination of the ISDA Master Agreement, all previously existing obligations under the individual derivative transactions, whether payment or delivery obligations, are replaced by a single payment claim. The ISDA Master Agreement governs how this settlement claim is to be determined.

What needs to be done?

The settlement amount is determined as of the Early Termination Date or, if this is not reasonably practicable, as of the earliest reasonably practicable date after the Early Termination Date. If the derivative transaction is to be replaced, then offers must generally be obtained by the Early Termination Date. Swift action is therefore necessary. If the transactions are not to be replaced, or if this is not possible (or at least not possible by the Early Termination Date), the further course of action must be decided on a case-by-case basis. As in other situations, waiting is not permissible in this situation either. Any early termination is an extraordinary situation. Even if swift action may be necessary, the overall situation should first be analyzed and all decisions should be documented.

How can you prepare for an emergency?

If an Event of Default, in particular a bankruptcy event, occurs, a fast decision on how to proceed is required. This makes it all the more important to prepare already when times are good, but applies all the more when dark clouds are beginning to gather on the horizon. Possible measures range from having all relevant documentation readily available, monitoring and documenting each transfer of individual transactions, to documenting whether automatic termination is planned and, if so, to which events this applies and whether it relates only to the counterparty or also to third parties.

If you have any further questions, please do not hesitate to contact our Banking and Litigation teams.

Authors: Dr. Jana Essebier, Dr. Christian Oetiker and Maximilian Riegel