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Market Disruption Event under the 2002 ISDA Equity Derivatives Definitions

The Tokyo Stock Exchange and “Early Closure”, “Exchange Disruption”, “Trading Disruption” and “Disrupted Day” under the 2002 ISDA Equity Derivatives Definitions

Around noon time on Wednesday, 18 January 2006, securities industry in Japan began to hear rumour that the Tokyo Stock Exchange might close early before the usual trading hours for reason that could not be verified at that time. Some traders in investment banks began ringing their legal departments to check. The announcement was eventually made by the Tokyo Stock Exchange around 2:30 pm.

Confusion followed and the question on the mind of those concerned was: Had there been a “Market Disruption Event”?

The market's first reaction was that a Market Disruption Event under the 2002 ISDA Equity Derivatives Definitions had occurred and it was caused by an “Early Closure” as defined under Section 6.3(d), something similar to what happened to the NYSE on 1 June 2005 where trading ceased at 3:56 without notice. An alternative view slowly emerged later, argued by those who bothered to read Exchange announcement referred to above. Rather than an “Early Closure”, it should be an “Exchange Disruption” under Section 6.3(c), they argued.

Many no doubt contacted ISDA Tokyo office looking for an authoritative view or urging the same to obtain counsel opinion on what happened. As a result ISDA Tokyo organised an urgent conference call at 10:30 am Tokyo time on 19 January 2006.

It was confirmed that rather than a closure (as reported in many foreign press, including the FT), what actually happened was a suspension of shares, convertible bonds around 14:40 but trading in futures and option was not affected. The Exchange remained open until the usual 15:00.

The decision to suspend trading was taken as the Exchange system was struggling to cope with a surge in selling orders (the limit is reported to be around 4,500,000 transactions) caused by a “perfect storm” as a trader was reported by the FT as saying: the investigation of Livedoor, disappointing results from Yahoo and Intel, among other things.

A lawyer who was at the ISDA organised conference suggested that, given the fact that the Exchange remained open and was not closed as earlier thought and not all trading is suspended, the incident should not constitute an “Early Closure” but instead, a “Trading Disruption” was more likely (although an “Exchange Disruption” was also possible). This view was echoed by a number of firms. One participant mentioned that there was a perception (especially from overseas) that an “Early Closure” had occurred based on secondary information from e.g. Bloomberg which came through later and not from the Exchange which announcement was only in Japanese.

Some firms then put forward the view (repeated a few times during the meeting and rather forcefully by Japanese standard) that even if “Trading Disruption” or “Exchange Disruption” had occurred, the ematerialityf was rather low, given the time of suspension and not least because most traders had no problem hedging their positions yesterday. One firm cautioned that not all firms would have the same ability to hedge their positions and another firm ventured that materiality should be judged according to the trading and hedging strategies of particular traders. One firm asked the meeting to reach a consensus on the question of materiality but the request was in the end not taken up.

The position is unlikely to become clear soon but until the Exchange system is upgraded, similar incident will repeat itself. Parties who act as the Calculation Agent will not have the luxury of sitting on the fence but must take a stance in deciding whether there had been a Market Disruption Event and make the necessary notification eas soon as reasonably practicablef under e.g. Section 6.4.


Last updated 19 January 2006

The above notes are intended to provide only general outlines and should be read in conjunction with, and are qualified in their entirety by, the full provisions of the relevant ISDA provisions and definitions. They should 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.

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