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Loan-linked hedging for the buy side – Part 2 (of 10): when things go wrong
This article examines hedging failures: premature trade terminations, HedgeBK suspending ongoing settlement payments, default contagion and adverse impact on hedged facilities. These emerge from different layers or facets of a trade.As an "ISDA Agreement", a trade faces termination risk and Section 2(a)(iii) Risk. Ongoing settlement payments by HedgeBK to HedgeCO may be suspended, unpaid, under MA s 2(a)(iii). A weakness for all hedging products, suspensions would become particularly vexing (1) after minor or "mid-grace period" Events of Defaults; or (2) for Prepaid Caps with premia already paid upfront on trading.
"Hedging Agreement" status is a double-edged sword. Once a trading or related document becomes a Hedging Agreement, it may, from there, evolve into a "Finance Document" for certain Facility Agreement events of default, increasing a Borrower's facility default risk. Conversely, in multi-tiered structures, Hedging Agreement status may be valuable. Hedge Counterparties are reined back, through the Intercreditor Agreement, from taking certain action under Hedging Agreements. For trades hedging debt in such structures, not being a Hedging Agreement presents risk: a common concern for some Prepaid Caps.
Finally, "Finance Document" breaches from hedging issues, substantively or definitionally, afford wide-ranging Lender remedies, culminating in acceleration of the very facilities the hedging was designed to protect.We build on concepts and definitions set out in Part 1 of the series.
Loan-linked hedging for the buy side – Part 1 (of 10): an introduction
