In July 2011, ISDA published the 2011 ISDA Equity Derivatives Definitions (the "2011 Definitions"). Within this publication is an entire Article, numbered 22, devoted solely to the "Calculation Dispute Resolution Procedure." At just over 15 pages in length and including additional terms that are defined elsewhere in the 2011 Definitions but that are used in this Article, one might wonder how a provision on the Calculation Agent dispute process takes up so much space. The answer is that there are many facets of and details as to how a Calculation Dispute Resolution Procedure can work. The role of the Calculation Agent is critical, as it is the party that makes determinations under transactions, such as adjustments for corporate events and how much money one party owes the other on one or more payment dates.
Which party is the Calculation Agent and whether or not that role is subject to dispute rights by the other party are questions that may be answered in a variety of ways in different forms of ISDA documentation. Dispute rights may be included in a confirmation governing a single transaction. They may also be included in master confirmations that govern certain types of trades, such as equity swaps. Sometimes dispute rights are embedded in the Schedule to the ISDA Master Agreement, where such rights may apply to all, or only certain, transactions entered into thereunder, and may apply differently to different asset classes. The Credit Support Annex to the ISDA Master Agreement has its own dispute resolution process that a party can invoke if it disagrees with the Valuation Agent's determination of the value of collateral and/or how much collateral should be delivered or returned. It is not only the location of dispute right provisions that varies, but the content and mechanics of the language and process. A dispute resolution provision may say no more than "determinations by the Calculation Agent are subject to agreement by the parties" or something to this effect. This leaves open the question of how long a party has to dispute a determination if the Calculation Agent didn't seek such party's agreement to the Calculation Agent's determination. Could the other party dispute in a week, in a month, in two months? A trade can have a single payment that isn't determined until years after the trade date. A provision may say that if the parties don't agree on the Calculation Agent's determination, they will pick a third-party dealer to resolve the matter. How long the parties have to agree on that third-party dealer and what happens if the parties do not agree is not always addressed.
Payment and delivery obligations under an OTC derivatives transaction can be significant. Having a clear and detailed dispute resolution process govern a transaction can mitigate issues associated with more open language. Article 22 of the 2011 Definitions contains such detailed provisions that can be incorporated into an over-the-counter equity derivatives transaction that incorporates the 2011 Definitions.
The Calculation Dispute Resolution Procedure in the 2011 Definitions contains hard-coded definitions and processes but also permits parties to make certain choices and to define certain methodologies in the future. For example, a party may initiate the dispute process only by notifying the Calculation Agent on or prior to the "Dispute Notice Deadline." This deadline may be determined (i) in accordance with a "Date Selection Methodology for Dispute Notice Deadline Dates," (ii) as an agreed number of days by the parties (e.g., two Reference Days after the Calculation Agent's effective notice to the other party of its determination), or (iii) by using the fallback in the 2011 Definitions, which is the third Reference Day after the Calculation Agent's effective notice to the other party of its determination.
Parties also have a choice of how much should get paid or delivered prior to the dispute being resolved. There are timelines for initiating a dispute, selecting third-party dealers, and when dealers that have been appointed must respond with a determination. Depending on how the relevant deadlines are defined, it could take a week or two (or more or less) until a dispute is resolved. The 2011 Definitions provide different alternatives that allow the parties to select how much a party should pay or deliver when the original payment or delivery is due. These are Payment/Delivery of Undisputed Amount Only, Payment/Delivery of Original Amount, Payment/Delivery of Half Disputed Amount, and Escrow of Disputed Amount.
Parties using the Calculation Dispute Resolution Procedure need to be cognizant of how these provisions work and what elections they are entitled to discuss and agree to with the other party. Some of the issues are as follows:
- Do parties want the dispute process to be anonymous?
- Should the determinations of the dealers polled be used to resolve the dispute or should there be a determination by the polled dealers as to whether or not the Calculation Agent's determination was commercially reasonable?
- What happens to the dispute resolution process if the disputing party is in default?
- What if not every dealer polled replies by the relevant deadline? In that case, depending on the type of determination, if only one or two dealers polled so reply, the result will depend on whether the parties have agreed that the "Minimum Number of Responders" would be one or two.
- What happens with mathematical determinations that can be averaged? This will depend on how many of the dealers polled respond by the relevant deadline, the agreed Minimum Number of Responders, and whether or not Dealer Poll was agreed. For example, if the four dealers polled respond by the relevant deadline, the Minimum Number of Responders is two, and Dealer Poll is specified, the determination will be the arithmetic mean of the two numbers that remain after removing the highest and lowest numbers.
Although the Calculation Dispute Resolution Procedure is part of the 2011 Definitions, ISDA is expected to publish a bridge so that parties can use its provisions in over-the-counter equity derivatives transactions that incorporate the 2002 ISDA Equity Derivatives Definitions. The Calculation Dispute Resolution Procedure contains valuable tools that can be used in documentation for other types of OTC derivatives transactions. There might be a benefit to the market having a consistent framework for settling disputes that a party has with the Calculation Agent for a transaction, although parties may make certain modifications to reflect differences among the asset classes. Time will tell whether or not the market will adopt some or all of the language in the 2011 Definitions beyond the scope of OTC equity derivatives transactions.