ISDA Schedule: What a Lender Negotiates in It

An ISDA master agreement has layers. The printed form, the 1992 or 2002 version published by the International Swaps and Derivatives Association, sets the general terms: payments, representations, events of default, termination events and how contracts are closed out. The Schedule records the choices the form leaves open and every amendment the parties agree. Each trade then gets a short confirmation with its own economic terms. Together they form a single agreement, so that on a default all the trades are closed out and netted to one amount. A credit support annex, where collateral is exchanged, attaches to the Schedule.

The printed form is not marked up, so anyone who knows it knows the starting point and has only to read the Schedule to learn what is different. Some banks document smaller business clients' hedges under their own standard dealing terms rather than a negotiated ISDA. Where an ISDA is used, the Schedule is where a borrower's adviser does the work.

The 2002 form's Schedule runs in five parts. Part 1, the termination provisions, holds the items a lender reads first: the specified entities whose defaults count, cross-default with its threshold amount, credit event upon merger, automatic early termination, the termination currency, and any additional termination events. Part 2 holds tax representations. Part 3 lists documents each party delivers. Part 4 covers notices, process agent, calculation agent, governing law and the credit support documents and providers. Part 5 carries everything else the parties change.

Four elections tie the hedges to the loan. The threshold amount sets how large a default on the client's other borrowed money must be before it is a default under the ISDA. The printed form's cross-default catches debt that has become due early or could be declared due and, in the 2002 form, a missed payment above the threshold; borrowers often negotiate this down to cross-acceleration, which waits until another lender has actually declared its debt due early. Additional termination events can let the bank end the hedges if the loan is accelerated, repaid or refinanced, or if the hedging bank stops being a lender. And the credit support documents name the guarantees behind the client, while the security documents, read with an all-monies clause, decide whether the close-out amount is secured.

A glasshouse tomato grower, constructed for this page, has a term loan from its bank with US$21m outstanding and a five-year swap of US$18m that fixes its rate. The Schedule sets the grower's threshold amount at US$500,000, keeps the printed form's cross-default, lets the bank terminate if the loan is accelerated or repaid in full, and names two subsidiaries' guarantees as credit support. These terms are the example's. Two years in, rates have fallen, and the swap would cost the grower US$650,000 to close.

First, the grower falls behind on a US$400,000 equipment loan from another lender. The amount is below the threshold, so nothing happens under the ISDA. Had it been US$600,000 and capable of being declared due, the bank could have ended the swap even though the grower's own loan was up to date.

Then the grower refinances with a competing bank. Repaying the loan in full is an additional termination event, so the old bank can close the swap, and its payout figure shows the result:

The grower's alternatives are to fund the US$650,000, or ask the new lender to take over the swap by novation, which needs the new lender's own credit line for it. Had rates risen instead, the close-out would have run the other way, with the bank paying the grower.

A confirmation records one trade: the notional, the fixed rate, the dates, the floating-rate source. The Schedule governs the relationship and every trade under it. A grower with four swaps has one Schedule and four confirmations, and on termination all four are valued and netted together.

The credit support annex is a collateral agreement: whichever party is out of the money posts cash or securities as the mark-to-market moves. Banks commonly require one from financial counterparties, but a business hedging its own loan more often relies on the loan security and posts nothing. The Schedule then does the work the annex would: it says which security and guarantees stand behind the client.

DEFINED IN ONE PARAGRAPH → · A SWAP, FROM THE BORROWER'S SIDE → · CROSS-DEFAULT →

At signing, the risk is a mismatch with the facility agreement. A loan that gives thirty days to remedy a breach sits badly beside an ISDA that can end the hedges at once, and a waiver from the lending side of a bank may not by itself waive an event under the ISDA. A borrower's adviser lines up the default events, cure periods and thresholds in both documents, and asks that a waiver under one covers the other.

At a refinance, the swap is the item that surprises. The outgoing bank's payout figure includes the close-out amount, and the incoming bank must approve a derivative credit limit before it can take a novated swap. At a default, the close-out turns a contingent, moving value into a fixed amount due at once, which ranks with the loan if the security secures it.

REFINANCING A BUSINESS LOAN → · THE PAYOUT FIGURE → · THE DERIVATIVE CREDIT LIMIT →