Coronavirus COVID-19 is having a serious financial impact across a whole range of sectors and industries. In recent weeks, the extreme volatility in the financial markets has had a particularly significant impact on the derivatives markets. Counterparties trading over-the-counter derivatives (OTC) such as foreign exchange, commodities and interest rates are finding (or will soon find) themselves in an extremely vulnerable position where they are left holding negative trades which are significantly “out of the money.”

In the wake of the UK government’s recent unprecedented quarantine measures, the position is only likely to get worse. This inevitably presents real challenges for both financial institutions and counterparties who are left making difficult contractual decisions to mitigate their financial losses. In particular, as financial institutions increasingly seek to make margin calls for additional collateral, this has brought force majeure, market disruption and dispute resolution clauses into very sharp focus. In this note, we consider the likely issues that may arise following such demands for additional collateral, together with some practical steps and measures that parties on both sides should consider and be aware of.

Executive summary

Faced with the prospect of making or receiving a margin call in the current climate, parties on either side of a derivative agreement should pay particular attention to the following:

  • Parties should first look to see if any specific market disruption or fallback provisions have been agreed. Often these will be contained in Schedules or Confirmations to an ISDA Master Agreement. If so, careful consideration should be given to see if any such provisions are triggered in the particular circumstances of the case.
  • Assuming any case-specific market disruption clauses do not apply, parties should check to see if any force majeure provisions are contained in their agreement(s). Unlike the 2002 ISDA Master Agreement, the 1992 ISDA Master Agreement does not contain a force majeure provision.
  • The force majeure provision in the 2002 ISDA Master Agreement will require a party to demonstrate that “by reason of force majeure or act of state” a party is “prevented,” or it becomes “impossible or impracticable” to make or receive a payment, or to comply with some other material provision. This will be fact-sensitive and depend on, for example, how any quarantine measures may be affecting a particular party.
  • If no market disruption or force majeure provisions apply, consideration should be given to whether or not a contract may be deemed to be frustrated by any unforeseen event(s), i.e. where performance of the contract has been rendered impossible.
  • In the event of a dispute following a margin call, careful consideration will need to be given to the dispute resolution provisions within the contractual agreement(s). In particular, parties should check carefully to see if any modifications to the standard dispute resolution provision in the Master Agreement have been made under a Credit Support Annex. The requirements under these notices will need to be strictly complied with. Failure to do so could have potential dire consequences for either party.

Credit Support Annex

Parties trading OTC derivatives will typically enter into a version of the ISDA Master Agreement (usually either the 1992 ISDA Master Agreement or the 2002 ISDA Master Agreement). These agreements are internationally agreed documents published by the International Swaps and Derivatives Association (ISDA). The Master Agreement will set out the overarching contractual terms between the parties, including terms governing default and termination. Parties will also enter into an ISDA Schedule which either alters or adds terms to the standard form ISDA Master Agreement. A Credit Support Annex (CSA) is one part of the ISDA Schedule and supplements the ISDA Master Agreement. Parties will also typically enter into transaction-specific “Confirmations.”

A CSA is a standard form collateral agreement that enables parties to either receive or provide collateral to reduce counterparty risk. In reality, this involves calculating the day-to-day exposure of the parties trading the OTC derivatives and requiring, for example, a counterparty that is “out of the money” on a particular day to provide additional collateral (typically in the form of additional cash) to the party that is “in the money.”

As equity markets have plummeted in recent weeks, and trillions of dollars have been wiped off stock markets, parties trading OTC derivatives have found themselves holding negative trades which are considerably “out of the money” and on the brink of insolvency. Financial institutions are left in the invidious position of having to decide whether or not to enforce collateral margin calls. Unsurprisingly, counterparties are exploring whether they can legally challenge the margin call requests in these unprecedented times.

Force majeure

Force majeure clauses will only apply in the absence of any more specific market disruption or fallback provisions. These should therefore be checked first. A force majeure clause is not (unless it has been specifically incorporated) a termination event in the 1992 ISDA Master Agreement. It is, however, included in the 2002 ISDA Master Agreement.

The force majeure clause in the 2002 contract is relatively basic. Section 5(2)(ii) states that a “Force Majeure Event” is one which “by reason of force majeure or act of state” results in a party, office or credit support provider being “prevented” from making or receiving a payment (or complying with some other “material provision”), or it becomes “impossible or impracticable” for one of them to, so long as it is “beyond the control” of the person in question and could not, after using all reasonable efforts (which will not require the person to incur a loss, other than immaterial, incidental expenses) to overcome the prevention, impossibility or impracticability.

The question arises whether either the coronavirus COVID-19 outbreak or the UK government’s quarantine measures restricting movement of individuals and ordering certain businesses to be shut could constitute a force majeure event. The answer in the context of a standard form 2002 ISDA will ultimately depend on the particular circumstances of the case and whether a party is being “prevented” and/or it becomes “impossible” or “impracticable” to continue to make payments or deliveries. In cases where payments or deliveries can continue to be made, it is unlikely that a party will be able to rely on the force majeure clause. However, as matters continue to evolve and quarantine measures place increasing restrictions on employees to travel to and from work, there may well now be circumstances where a counterparty, unlike a financial institution that may have multiple offices, may be left unable to make a payment or delivery because an employee is unable to attend the workplace to make, authorise or authenticate a payment. Financial institutions, in particular, will need to be cognisant of any such constraints that their counterparties may be facing.


In contracts where there is no force majeure clause (for example, in the 1992 ISDA Agreement), the doctrine of frustration may be relevant.

Frustration allows a contract to be discharged when an unforeseen event occurs that renders the performance of the contract impossible. Unsurprisingly, the threshold is very high and the test is strict. It requires:

  • the relevant event to have occurred after the contract was formed and for it to fall outside of the contemplation of the parties at the time of entering into the contract;
  • neither party to be at fault; and
  • the performance of the contract to be rendered impossible, illegal or radically different.

Like the analysis above, it will not be sufficient for a party to merely assert that performance of the contract has become more difficult or uneconomic. It will require a party to prove that the contract cannot be performed.

Unsurprisingly, parties should exercise a great deal of caution before seeking to rely on a force majeure provision or to invoke frustration. Parties, particularly regulated clients, should also consider the likely wider reputational and regulatory risks of wrongfully unilaterally opting to rely on such provisions.

Market disruption

Specific derivatives agreements may contain “Market Disruption” provisions which may be more relevant in light of coronavirus COVID-19 than the more generic and basic force majeure provisions in an ISDA Agreement. For example, the 2002 ISDA Equity Derivatives Definitions contain a specific definition of “Market Disruption Event.” This is defined as meaning in respect of a share or an index, the occurrence or existence of (i) a Trading Disruption, (ii) an Exchange Disruption or (iii) an Early Closure. Certainly, in light of events in China, Italy and Spain, it is entirely plausible that derivatives linked to shares on exchanges in those jurisdictions may well fall within this definition.

Similarly, the 1998 FX and Currency Option Definitions contains a “Disruption Event” definition. This is defined as being an event that would give rise to either an alternative basis for determining a settlement rate or an alternative basis for settling the transaction (which may include “no-fault termination” of that transaction). Again, it is entirely feasible that if markets continue to plummet, and the clamour for suspension of trading continues, that a “Disruption Event” clause may be triggered.

Practical considerations

From a practical perspective, perhaps more important in these times will be the need for parties on both sides to follow the strict contractual requirements when serving and/or challenging any margin calls under a CSA. Inevitably, the precise requirements will depend on the contractual terms agreed between the parties (and specifically the form of the CSA that the parties are using; for example, whether it is the 1994 CSA, or the 2016 / 2018 CSA for Variation / Initial Margin). However, some practical tips and reminders are set out below:

  • Prior to relying on any force majeure provision, parties should look carefully at the full suite of contractual documents, including Confirmations and Schedules to ascertain whether any market disruption provisions are likely to be relevant and/or will apply in light of coronavirus COVID-19 and/or the current quarantine measures (both in the UK and elsewhere).
  • Parties must pay close attention not only to the standard form CSA provisions but also to any bespoke modifications or elections made under the CSA. For example, the dispute resolution clause in a 2016 CSA is contained in paragraph 4. This sets out the various requirements if a margin call is disputed between the parties. The parties may, however, have agreed a bespoke dispute resolution provision in paragraph 11 under “Elections and Variables.” This may, for example, require a party challenging any margin call to set out an alternative calculation (which is not a requirement under the standard paragraph 4 of the 2016 CSA). In this case, the bespoke provision under paragraph 11 would trump the standard wording in paragraph 4.
  • Of particular importance is that the parties ensure compliance with all relevant deadlines. The deadlines for compliance, particularly when challenging margin calls, are very short and strict. Under paragraph 4 of the 2016 CSA, a party disputing a calculation of either a “Delivery Amount” or a “Return Amount” must notify the other party no later than close of business on the date that a transfer for collateral is due (which will usually be the same or following day).
  • Where a party is disputing a payment, it does not absolve that party from paying / transferring the undisputed amount to that other party. The undisputed amount would need to be paid by no later than close of business on the date the transfer of “Delivery Amount” or “Return Amount” is due.
  • Careful consideration should be given to the variation provisions in the contract(s). In particular, since most notice provisions will require notices of default / margin calls to be served personally by hand or courier, it would be prudent given the increasing global travel restrictions for parties to seek to agree alternatives for service, such as by fax or email. Plainly, the parties will be more willing to agree to such variations prior to any dispute arising.
  • In times of such uncertainty and volatility, it is imperative that parties ensure that in taking any decisions they ensure their wider contractual rights are being expressly reserved.
  • Finally, perhaps the most important tip given the potentially draconian consequences of making a false move (particularly the risk of potentially triggering cross-default provisions and insolvency) is to ensure that prompt legal advice is sought as soon as any issue relating to a potential margin call arises or appears likely to arise.