On Friday, February 27, 2009, ISDA published its Close-out Amount protocol (the “Protocol”). The Protocol provides participants in the derivatives market a streamlined way to amend the 1992 ISDA Master Agreement so that termination payments are determined according to the Close-out Amount method used in the ISDA 2002 Master Agreement, rather than the ISDA 1992 Master Agreement’s Market Quotation or Loss methods. Under the Protocol, a participant can amend multiple master agreements with only one signed document, precluding the need for a bilateral amendment with each counterparty.
Not every participant will want to move to the Close-out Amount method for determining termination payments. Some participants will continue to prefer Market Quotation or the more subjective Loss method. Described in simple terms, Market Quotation is an objective approach that uses quotes from sources external to the party making the determination. The Loss method is more flexible, with a party choosing any approach to determine its loss or gain resulting from termination of transactions, subject only to standards of reasonableness and good faith. The Close-out Amount method falls somewhere in between, giving the determining party flexibility to choose its approach, but holding it to a standard of commercial reasonableness.
Each participant can make its own decision as to whether it wants to amend its master agreements that are in the form of the 1992 ISDA Master Agreement to incorporate the Close-out Amount method and, if so, whether it will sign onto the Protocol. The participant who wants to substitute Close-out Amount for some but not all of its counterparties may have to enter into bilateral amendments—either to effect the substitution for particular agreements (if it does not sign onto the Protocol) or to nullify the effect of the Protocol where it wants to retain its current approach (if it does sign onto the Protocol).