In response to member feedback related to the Covid-19 pandemic and recent global sanctions, the International Swaps and Derivatives Association, Inc. (ISDA) established a working group (consisting of a broad range of buy-side and sell-side members) to consider (i) refinements to the standard notice provisions of the ISDA 2002 Master Agreement (the 2002 Agreement) and (ii) alignment of the treatment of ISDA Credit Support Annexes in the context of the Illegality and Force Majeure Event provisions of the 2002 Agreement. Following such consideration, ISDA has published a set of amendments (the Amendments) which enable market participants to agree to certain changes to the 2002 Agreement, including (1) adding email as a means of delivering notices under Section 5 (Events of Default and Termination Events) or Section 6 (Early Termination: Close-Out Netting) of the 2002 Agreement, (2) introducing a “Notice Delivery Cut-off” concept and (3) incorporating changes to conform the treatment of the English law Credit Support Annex to that of the New York law Credit Support Annex in the event of an Illegality or a Force Majeure Event.
This briefing provides an overview of the recently published Amendments.
Amendments to Section 12(a) (Notices)
Email notices in respect of Section 5 and Section 6
Pursuant to Section 12(a) (Notices) of the 2002 Agreement, a notice or other communication under Section 5 and Section 6 of the 2002 Agreement may not be given by email. The standard provision may be modified, supplemented, and/or overridden in the Schedule to the 2002 Agreement or by the Confirmation for a particular Transaction. In some instances, market participants have included provisions in the ISDA Schedule or Confirmation to permit notice of defaults and/or terminations via email. However, in the majority of derivative contracts, Section 12(a) of the 2002 Agreement remains unchanged, and email is not a permitted method of delivery in a default scenario.
Due to Covid-19 pandemic restrictions, the effective delivery of certain notices proved challenging, and this led to an ad hoc process in which notices were often delivered by multiple means, sometimes in ways not specifically contemplated by the 2002 Agreement. It became apparent that there was demand for alternative methods for delivering notices under Sections 5 and 6 of the 2002 Agreement. Similar experiences in relation to the insolvency of Lehman Brothers demonstrated that difficulties delivering and monitoring receipt of these kinds of notices can lead to significant valuation impacts and litigation risk. In light of the foregoing, the Amendments provide parties with a standardised method to agree an amendment to Section 12(a) of the 2002 Agreement so that notices and/or other communications under Section 5 or 6 may be given by email.
However, the introduction of email as a new method for delivering Section 5 and Section 6 notices raises important issues which require consideration, such as what needs to be accomplished to effectively deliver an email notice and timing of such notice.
Effectiveness of email notices/communications
Section 12(a) of the 2002 Agreement provides that a notice or other communication in respect of the 2002 Agreement delivered by email to the email details provided by a party will be deemed effective on the date that the email is delivered. However, given that the Amendments revise Section 12(a) to permit email notices in the context of Sections 5 and 6 of the 2002 Agreement, the ISDA working group determined that the 2002 Agreement needed to be more detailed as to what must be shown to establish that an email has been effectively delivered. In light of this, the Amendments change Section 12(a)(vi) of the 2002 Agreement to clarify that an email notice will be deemed effective on the date that it is relayed to the recipient’s email infrastructure. The revised Section 12(a)(vi) further provides that the parties agree that a relay to the recipient email infrastructure can be evidenced by, amongst other things, data captured by the sender’s email infrastructure (whether or not such data includes data from the recipient’s email infrastructure). It is important to note that the data/report captured by the sender’s email infrastructure is an example of the type of evidence that a sender can rely on (rather than an exhaustive list) and market participants may rely other data and/or evidence to demonstrate that an email has been successfully relayed to the recipient’s email infrastructure.
Notice Delivery Cut-off
Having considered how delivery of a notice by email can be evidenced, another important consideration is the timing of such delivery. Section 12(a) of the 2002 Agreement states that notices or communications that are delivered, attempted to be delivered or received after the “close of business” on a Local Business Day are deemed effective on the next Local Business Day. However, the 2002 Agreement does not include a definition of “close of business” and provides no guidance as to what “business hours” may be. What market participants may consider to be “close of business” may vary from party to party and could also differ between jurisdictions.
The timing of whether a notice is delivered before or after “close of business” could be of particular relevance, for example, where both parties are able to designate an Early Termination Date and the question is which one did so first. Furthermore, given that the 2002 Agreement provides that an Early Termination Date cannot be earlier than the effective date of the notice relating to the relevant Event of Default or Termination Event, what constitutes “close of business” is a significant consideration and often forms part of the discussion in court proceedings when market participants seek to dispute the validity and timing of close-out notices served under the 2002 Agreement. In light of this, the Amendments remove the concept of “close of business” and replace it with a “Notice Delivery Cut-off”, which is defined as the “Notice Delivery Cut-off Time” in the “Notice Delivery Location”. In relation thereto, the Amendments introduce a new section at the end of the Schedule to the 2002 Agreement which incorporates the definitions of Notice Delivery Cut-off Time (which is to be agreed and specified by the parties, but with a default of 5 p.m. in the location of the recipient) and Notice Delivery Location (which is the city, region, or country specified for such party).
The introduction of a “Notice Delivery Cut-off” mechanic to introduce some objectivity to the concept of “close of business” is a welcomed change. Validly serving contractual notices under standard form agreements (not only the 2002 Agreement, but also other standard agreements such as the Global Master Repurchase Agreement (GMRA) and the Global Master Securities Lending Agreement (GMSLA)) is a continuing pitfall for clients and what constitutes “close of business” often forms part of the debate. The meaning of “close of business” depends on the context (such as the deadline generally imposed for the receipt of notices in a standard form financial contract) and the individual facts of each case. In Lehman Brothers International (Europe) v Exxonmobil Financial Services BV  EWHC 2699 (Comm), for instance, Blair J rejected an argument that such concept in a GMRA means 5.00 p.m. and the decision pointed out that, in the modern world, commercial banks carry on business much later than this.
Practical issues to bear in mind
Notwithstanding the amendments made to Section 12 of the 2002 Agreement, it is generally recommended that any notice provided by market participants under the 2002 Agreement be given by at least two permissible methods of delivery, including hand delivery to the address provided for the receiving party in Part 4(a) (Address for Notices) of the Schedule (or otherwise specified in the relevant transaction Confirmation). This will reduce the risk of notices not being able to be delivered and any disputes by the other party.
Parties will also need to ensure that they include email address details in the Schedule in order for email to be a viable method of delivering notices under the 2002 Agreement. For instance, in Greenclose Ltd v National Westminster Bank PLC  EWHC 1156 (Ch) Andrews J concluded that the statement in Section 12(a) that notices and other communications in respect of the 2002 Agreement “may be given in any manner as set forth below” means that they may only be given in such a manner.
Changes to align the treatment of English law and New York law Credit Support Annexes in the event of an Illegality or Force Majeure Event
Treatment of Credit Support Annexes in the event of an Illegality or Force Majeure Event
Both the Illegality Termination Event (Section 5(b)(i) (Illegality)) and the Force Majeure Termination Event (Section 5(b)(ii) (Force Majeure Event)) in the 2002 Agreement make a distinction between (1) payments and deliveries under a Transaction and (2) payments or deliveries under a Credit Support Document. With respect to payments and deliveries under a Transaction, the Affected Transactions may be terminated only if the relevant Termination Event is continuing and the applicable “Waiting Period” has expired, whereas in the case of payments or deliveries under a Credit Support Document, no Waiting Period applies if performance thereunder has already fallen due. The distinction is important, as the party with the collateral payment or delivery obligation is protected from being unable to make payment under a Transaction due to a Force Majeure Event or an Illegality by the application of a Waiting Period, but it is not protected from making a collateral payment under a Credit Support Document due to a Force Majeure Event or an Illegality, as no Waiting Period applies. This reflects the significance of collateral obligations in managing credit risk: if collateral is no longer being provided, a right to terminate should arise immediately.
Only obligations under agreements or instruments that have been specified as “Credit Support Documents” for the purposes of the 2002 Agreement (such as the 1995 ISDA Credit Support Deed governed by English law or the 1994 ISDA Credit Support Annex governed by New York law (the NY Law CSA) (i.e. security interest credit support arrangements) or any agreements or instruments specified as such in Part 4 of the Schedule to the 2002 Agreement) will fall within the second limb. In contrast, the 1995 ISDA Credit Support Annex governed by English law (the English Law CSA) (i.e. the title transfer CSA) will fall within the first limb, due to the fact that an English Law CSA is deemed to be a Transaction under the 2002 Agreement.
Independently of whether the different treatment of the various credit support documents was intentional or not, this is something that has caused discomfort among some market participants. Particularly in the collateral delivery environment of today, where parties are used to sending and receiving collateral on a daily basis, the distinction between collateral delivered under a title transfer CSA and collateral delivered under a security interest credit support arrangement is unpalatable to some market participants. On this basis, when ISDA initially consulted members on whether treatment of English Law CSAs and NY Law CSAs should be aligned, the majority of participants responded in favour.
It is also important to note that, when calculating the “Close-out Amount” with respect to an Illegality or a Force Majeure Event, Section 6(e)(ii)(3)(A) (Mid-Market Events) of the 2002 Agreement provides for third party quotations to not take into account “any existing Credit Support Document”. In addition, pursuant to Section 6(b)(iv)(2)(A) (Right to Terminate) of the 2002 Agreement, either party would have the right to terminate upon the expiry of the relevant Waiting Period following the occurrence of a Force Majeure Event or an Illegality with respect to a payment or delivery obligation relating to a Transaction, however with respect to a payment or delivery obligation relating to a Credit Support Document, the Affected Party only has the right to terminate following the prior designation by the Non-Affected Party of an Early Termination Date in respect of less than all Affected Transactions. Therefore, whether a credit support arrangement is considered to be a Transaction or a Credit Support Document will also have an impact on how it is treated for these purposes.
In light of the above, and based on the feedback received from market participants, the Amendments aim to harmonise the treatment of English Law CSAs and NY Law CSAs. Consequently (i) if obligations have become due under the parties’ English Law CSA, no Waiting Period will apply, (ii) an Affected Party will only have the right to designate an Early Termination Date under Section 6(b)(iv)(2)(A) (Right to Terminate) of the 2002 Agreement following the prior designation by the other party of an Early Termination Date in respect of less than all Affected Transactions and (iii) any such English Law CSA will not be taken into account when obtaining third party quotations for the purposes of determining the “Close-out Amount” as per Section 6(e)(ii)(3)(A) of the 2002 Agreement.
It is not surprising that the Amendments have opted for English Law CSAs to be treated as if they were a Credit Support Document, thereby enabling the Non-Affected Party to terminate immediately if the performance by a party or its Credit Support Provider of an obligation to make a payment or delivery under a Credit Support Document has fallen due but it has been prevented from complying with such obligation as a result of a Force Majeure Event or an Illegality. Ultimately, this highlights the importance of collateral obligations in managing credit risk and reflects the prevalent practice of sending and receiving daily collateral payments.
Whilst the Amendments represent welcomed changes, we will have to wait and see how the industry reacts and what the market uptake is. Although the Amendments provide market participants with optional standard amendments that allow parties to bilaterally agree for email to be a permitted means of delivering Section 5 and 6 notices to pre-specified addresses, the working group recognised that contractual amendments cannot completely address all the challenges encountered by market participants when trying to deliver, or monitor receipt of, notices delivered under the 2002 Agreement. In light of this, ISDA is currently considering the launch of an online platform to allow certain critical notices under the 2002 Agreement (and potentially other agreements) to be securely delivered and received online. This is an ambitious initiative which will likely be of significant interest to many market participants. This is therefore a space that will, no doubt, continue to evolve over the coming months and which we will continue to observe.