ISDA proposes Form of Amendment for nickel market disruption fallbacks: understanding the options
On March 24, 2022, the International Swaps and Derivatives Association (ISDA) issued a form amendment that would allow parties to existing transactions to choose between one of three options on how they might amend the definition of Disruption Fallback in their ISDA confirmations to address the March 2022 Market Disruption Event with respect to nickel.
Though the definition of Disruption Fallback may not be often used, it is a feature of parties’ transactions and one that can affect how monthly average settlement prices and notional average prices are calculated. Accordingly, parties to transactions and confirmations that use nickel for their commodity reference price may find the form amendment useful to avoid calculation uncertainty in their agreements.
To contextualize the amendment, this article first discusses what led to the form amendment being proposed. Next, it turns to the options that the form amendment presents, and finally we offer several concepts that parties might consider before revising their transactions.
On March 8, 2022, the London Mercantile Exchange (LME) announced that it was going to (a) suspend trading of LME nickel contracts as of that morning and until a certain resumption date and (b) temporarily cease publishing official prices/closing prices on nickel contracts during this suspension.
As a result of events described in LME’s notice above, ISDA calculation agents could determine, after consulting with parties, if a Market Disruption Event occurred. Unless a transaction otherwise provided in the ISDA or confirmation, a Market Disruption Event occurs when, among other possibilities, the price source used to calculate the relative price for the referenced commodity is temporarily discontinued or unavailable.
Accordingly, with LME not publishing the official price/contract price for nickel contracts, calculation agents could reasonably find that a price source disruption occurred (when nickel was used as the commodity reference price) and therefore that a Market Disruption Event existed.
With the Market Disruption Event definition satisfied, calculation agents turned to the definition of Disruption Fallback to determine the relevant price for the specified commodity reference price for nickel. This allowed them to calculate the monthly average settlement prices and notional average prices.
Practically, because the LME suspended publishing the official price/closing price for LME nickel contracts at the same time trading on such contracts was suspended, the methodology for how to calculate a commodity reference price became uncertain, ultimately affecting the monthly average settlement price and notional average price in an agreement.
Addressing this uncertainty, on March 14, 2022, LME announced (LME Notice 64), that the official price/closing price for each affected business day on which a Disruption Event occurred would be the next available official price/closing price, which became published on March 22, 2022.
In light of these events, certain members requested that ISDA produce an amendment that could be used by market participants who desired another Disruption Fallbacks definition; they desired more than the definition provided. ISDA published the form amendment on March 24, 2022 but with language narrower than the form amendment introduced on March 17, 2022, which would have allowed the same methodology for monthly averaging in relation to disrupted days for all base metals.
The form amendment aims to enable parties to replace the Disruption Fallbacks procedure applicable to their existing transactions with one three alternatives, summarized below:
- Under Option 1, parties use the next official price/closing price for disrupted days
- Under Option 2, parties apply the calculation agent’s relevant price determination or
- Under Option 3, parties may introduce a bespoke Disruption Fallback.
Option 1 would use the LME official price/closing price for the next day on which the official price/closing price is published even if it is published on a day on which a Market Disruption Event has occurred. This price would continue to apply to Market Disruption Events occurring during the remaining term of in-scope transactions. This price would only be used for nickel pursuant to the form amendment.
Option 2 would allow the calculation agent to determine the relevant price taking into consideration the latest available quotation for the relevant commodity reference price and any other information that in good faith it deems relevant.
Option 3 would allow parties to specify or describe an alternative Disruption Fallback other than the two described above.
ISDA helpfully provided a list of considerations for parties to discuss before modifying their agreement pursuant to the form of amendment. However, the list is not exhaustive, and market participants are encouraged to review their agreements and confirmations with outside counsel before committing to a revised transaction structure:
- Alternative Disruption Fallbacks. Parties should recognize that the options presented by the form amendment are not exhaustive. Parties may wish to consider if any other alternative Disruption Fallbacks are appropriate.
- Alignment between Disruption Fallback under the amendment covered document and LME approach to disrupted days. One option for an alternative Disruption Fallback is to use the next official price/closing price which is the price published by LME on March 22, 2022. This allows market participants to align the outcome under their transaction with the methodology presented in LME Notice 64.
- Use of LME methodology in relation to non-averaged transactions. Market participants are encouraged to consider whether using the next official price/closing price for calculating average price and single pricing date prices is appropriate.
- Application of fallback provisions limited to the March 2022 Nickel Market Disruption Event. The Disruption Fallback that market participants specify to apply will apply only with respect to the March 2022 nickel Market Disruption Event, unless parties state otherwise. If a Market Disruption Event under the commodities definition occurs at a later date, either the Disruption Fallbacks set forth in the confirmation or default Disruption Fallbacks applies.
- Form amendment applying to existing transactions only. The Form of Amendment only contemplates the amendment of transactions entered into before March 8, 2022.
- Deferral of delivery date by LME. LME announced the delivery date for all nickel contracts due for delivery between March 16, 2022 and March 22, 2022 is deferred to March 23, 2022. Parties are encouraged to consider if this delivery deferral impacts any of their OTC transactions hedged with exchanged nickel contracts that are subject to the delivery deferral.
For any questions related to the ISDA form of amendment, please contact DLAPiperCommodities@dlapiper.com or any of the authors on this Commodities Alert.