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2002 ISDA Equity Derivatives Definitions

 

ISDA 2002 Equity Derivatives Definitions Guide

Equity Derivatives Transactions (1.1) | Equity Notional Reset (5.10) | Dividend Amount (10.1) | Index Adjustment Events (s. 11.1) | Additional Disruption Events (12.9) | Hedging Party (12.9(a)(ix) |

Background

ISDA published the 2002 ISDA Equity Derivatives Definitions on 6 January 2003. It is the successor to the 1996 ISDA Equity Derivatives Definitions and are also designed to provide a standard documentation framework for over-the-counter equity derivatives transactions.

New Covered Products

ISDA published the 2002 ISDA Equity Derivatives Definitions on 6 January 2003. The 2002 ISDA Equity Derivatives Definitions are the successor to the 1996 ISDA Equity Derivatives Definitions and are also designed to provide a standard documentation framework for over-the-counter equity derivatives transactions. In addition to the mechanics of an equity derivatives transaction, it is said to have a “toolbox” approach of standardized and elective provisions that give the parties the freedom to tailor the equity derivatives transaction.

Equity Forward

The 1996 ISDA Equity Derivatives Definitions cover only equity option and swap and the 2002 ISDA Equity Derivatives Definitions add “forward” equity transactions to the product range.

The 2002 ISDA Equity Derivatives Definitions now cover three product types:

(a) Options

(b) Swaps

(c) Forwards,

and the following 'underlyers ':

(a) share and share baskets

(b) index and index basket

Bermuda Options

The provisions for “Bermuda” option (i.e. exercisable on pre-determined “Potential Exercise Dates”) have also been added in addition to American and European type options under the 1996 ISDA Equity Derivatives Definitions.

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Settlement

The cash or physically settlement mechanics under the 2002 ISDA Equity Derivatives Definitions is said to be “delinked” from a particular product (i.e. options in the 1996 ISDA Equity Derivatives Definitions) andnow apply to all product types i.e. option, swap and forward (except index or index basket transactions which are cash settled).

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Knock-in, Knock-out

The 2002 ISDA Equity Derivatives Definitions also include barrier provisions of knock-in and knock-out. If “Knock-in” applies, the buyer pays a premium and receives an option which is exercisable when the underlying share or index reaches an agreed level. If “Knock-out” applies, the transaction will be terminated if the underlying share or index reaches an agreed level.

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Reverse Merger, Tender Offer

New trigger events i.e. Reverse Merger under s. 12.1(b) of the 2002 ISDA Equity Derivatives Definitions (applies to Share-for-Share Merger Event only) and Tender Offer under s. 12.1(d) of the 2002 ISDA Equity Derivatives Definitions (whereby a transaction may be terminated if less than 100% but more than 10% of the relevant outstanding shares are offered to be acquired) are added to the 2002 ISDA Equity Derivatives Definitions.

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Exercise Date

Exercise Date has been amended (changing Exchange Business Day to Scheduled Trading Day) so that an option can be exercised on a day which the Exchange or Related Exchange is scheduled to open but actually does not (cf. 3.1(b) of 2002 ISDA Equity Derivatives Definitions).

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Market Disruption Event

Market Disruption Events have been expanded to include “Trading Disruption”, Exchange Disruption and Early Closure (cf. 6.3 of 2002 ISDA Equity Derivatives Definitions).

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Valuation

Under the 2002 ISDA Equity Derivatives Definitions, a Valuation Date will be postponed up to a maximum of 8 Scheduled Trading Days if a Disruption Day occurs (cf. 6.6 of the 2002 ISDA Equity Derivatives Definitions).

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Dividend

Section 7.12 of the 1996 ISDA Equity Derivatives Definitions was expanded to the new Article 10 in the 2002 ISDA Equity Derivatives Definitions.

Dividend Amount now includes to Record Amount, Ex Amount and Paid Amount and Dividend Period now includes First Period and Second Period.

Please also see this article for more on dividend.

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Consequences of Merger Event and Tender Offer

The consequences of Merger Event and Tender Offer set out in the 2002 ISDA Equity Derivatives Definitions (12.2 and 12.3) are similar except that Alternative Obligation applies only to Merger Event. The consequences are:

(a) Alternative Obligation

(b) Cancellation and Payment

(c) Option Exchange Adjustment

(d) Calculation Agent Adjustment

(e) Modified Calculation Agent Adjustment

(f) Partial Cancellation and Payment (applies to basket transactions only)

(g) Component Adjustment (applies to Share-for-Combined Merger Event Only)

If Cancellation and Payment is applicable, an equity swap or forward transaction will be terminated by the payment of a Cancellation Amount (12.7(c)). For an option transaction, the transaction will be terminated by the payment of an amount calculated either according to the Agreed Model under 12.7(b)(ii) or an amount determined by the Calculation Agent under 12.7(b)(ii) if Calculation Agent Determination is specified to be applicable.

Under Calculation Agent Adjustment, it is noteworthy that if no adjustment would produce a 'commercially reasonable result', the transaction will be terminated as if Cancellation and Payment applied. In addition, in such a case and in respect of an option transaction, the payment shall be calculated as if Calculation Agent Determination applied (cf.12.2(d)). /p>

Modified Calculation Agent Adjustment is similar to Calculation Agent Adjustment (including the application of Cancellation and Payment discussed above) except that the Calculation Agent may take into account changes in volatility, expected dividends, stock loan rate or liquidity relevant to the shares or transaction.

Partial Cancellation and Payment has basically similar effect as Cancellation and Payment save that only shares affected by the Merger Event will be cancelled.

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Additional Disruption Events

The 2002 ISDA Equity Derivatives Definitions also set out certain additional events called Additional Disruption Events in 12.9 which if occur would cause the transaction to be terminated (by payment of a Cancellation Amount under 12.8) unless the relevant party takes avoidance steps described below. These Additional Disruption Events include:

(a) disruption events relating to hedging i.e. Hedging Disruption, Increased Cost of Hedging, Loss of Stock Borrow, Increased Cost of Stock Borrow;

(b) Change in Law (12.9(a)(ii))

(c) Insolvency Filing (12.9(a)(iv)) which triggers the termination of the transaction upon the filing/commencement of the proceedings (N.B. this is different from Insolvency under 12.6(a)(ii))

(d) Failure to Deliver (12.9(a)(iii)) shares due to illiquidity (such failure does not constitute an Event of Default under the ISDA master Agreement and applicable only to physically settled transactions)

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Avoidance of Termination

If Increased Cost of Hedging occurs, the non-hedging party can avoid termination by paying the hedging party a Price Adjustment (cf. 12.9(a)(xv) and 12.9(b)(vi) and 12.9(b)(vi)).

If Loss of Stock Borrow occurs, the non-hedging party can avoid termination by:

(a) lending the relevant shares to the hedging party at a rate not more than the Maximum Stock Loan Rate;

(b) referring the hedging party to a Lending Party who would lend the relevant shares to the hedging party at a rate not more than the Maximum Stock Loan Rate

If Increased Cost of Stock Borrow occurs, the non-hedging party can avoid termination by:

(a) lending the relevant shares to the hedging party at a rate not more than the Initial Stock Loan Rate;

(b) referring the hedging party to a Lending Party who would lend the relevant shares to the hedging party at a rate not more than the Initial Stock Loan Rate

derivativeslawyer.com

Last updated February 2012

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The above notes are intended to highlight issues and provide only general outlines and not intended to be comprehensive nor legal advice. Where applicable, the same should be read in conjunction with, and are qualified in their entirety by, the full provisions of the relevant ISDA provisions and definitions. They shall never be used in place of professional advice. We accept no responsibility for any loss arising from any action taken or not taken by anyone using this material or using this material in conjunction with any ISDA documentation in reliance thereof. If you have any question, please contact us.

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