If the parties have documented their repo business under a master agreement, such as the ICMA’s Global Master Repurchase Agreement (GMRA), default means that one of the parties has committed one of the Events of Default listed in the agreement. In the GMRA, the standard list of Events of Default includes Acts of Insolvency such as the presentation of a petition for the winding-up of the party or the appointment of a liquidator or equivalent official. Other standard Events of Default are:
- failures to pay cash amounts (such as purchase price, repurchase price and manufactured payments) or to meet variation margin calls;
- making an admission of one’s inability or intention not to meet debts as they fall due (under the GMRA 2000, this admission has to be in writing);
- making materially incorrect or untrue representations;
- being suspended or expelled from a securities exchange for specified reasons or (under the GMRA 2000) from a self-regulatory organisation;
- being suspended for specified reasons from dealing in securities by an official body (a ‘government agency’ under the GMRA 2000 or ’Competent Authority’ under the GMRA 2011, the latter term being intended to include the new types of agency established in the wake of the Great Financial Crisis, such as resolution authorities);
- (under the GMRA 2000) having assets transferred to a trustee by a regulator.
Under the GMRA 2000, the occurrence of either of two particular Acts of Insolvency --- the filing of a petition for the winding-up of a party and the appointment of a liquidator or similar officer --- automatically puts the insolvent party into default. For all other Events of Default, under the GMRA 2000, a party is not actually in default until its counterparty serves a default notice. Under the GMRA 2011, a party is in default as soon as an Event of Default occurs: notice is necessary only to initiate the process of terminating the agreement.
Default notices under the GMRA must be served in writing in English. They can be delivered:
- in person or by courier;
- by registered mail;
- by telex (but not under the GMRA 2011);
- by fax;
- in the form of an electronic message which is capable of reproduction in hard copy (under the GMRA 2011, but not the GMRA 2000, electronic messaging includes e-mail).
Under the GMRA 2000, once a party is formally in default, the process of close-out netting starts. Under the GMRA 2011, close-out netting requires the non-defaulting party to serve a notice specifying a termination date or as soon as an Event of Default has occurred that the parties have pre-agreed should be subject to Automatic Early Termination. Close-out netting has three stages.
- First, all outstanding obligations due on repos documented under the same GMRA are accelerated for immediate settlement and all variation margin held by the parties is called back.
- Second, the Default Market Value of the collateral securities is fixed and transactions costs and professional expenses included. The non-defaulting party can also add the cost of replacing defaulted repos or, if he considers it reasonable, the cost of replacing or unwinding hedges.
- Third, all sums are converted into the same currency (the one chosen as the Base Currency by the defaulting party when the GMRA was negotiated) and are netted off against each other to produce a single residual amount, which must be notified to the defaulting party. Whoever owes the residual sum must pay it by the next business day. Either party can be charged interest on late payment.
The non-defaulting party cannot use the close-out netting process to try to recover what are called consequential losses (with the exception of the cost of replacing repos or the cost of replacing or unwinding hedges). These are downstream losses caused by the default (those not immediately due to the default on repos).
The default procedure in the GMRA was thoroughly tested by the default of Lehman Brothers in September 2008. It worked well and the netting of credit exposures under the GMRA and other standard master agreements (eg the Global Master Securities Lending Agreement and the ISDA Master Agreement) significantly mitigated the impact of Great Financial Crisis. Accordingly, the changes to the default procedures introduced by the GMRA 2011 are not fundamental. They are generally intended to give the non-defaulting party more flexibility in calculating the Default Market Values of collateral and to align the provisions of the GMRA more closely to standard master agreements in other markets.
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