Buy-Side Checklist for Potential Impacts on Counterparty Trading Arrangements

With the increasing concerns surrounding the impact of COVID-19 around the world, global financial markets are facing a unique set of difficulties. Fund managers, family offices and other buy-side market participants should consider reviewing their counterparty trading and brokerage arrangements to understand the impact of these events on their trading portfolios and their counterparties.

Below is a checklist of high-level issues that clients may wish to consider during these challenging times in the context of their counterparty trading and brokerage relationships.

• Force Majeure Events: Review force majeure provisions to determine the scope of events that may constitute a “force majeure event” and understand the implications and consequences (i.e., whether a party is permitted to defer performance or terminate).

• Market Disruptions/Trading Disruptions: Assess the impact of any exchange closures, halts/limitations in trading or other market/trading disruptions and evaluate the applicability of fallback valuation methodologies, trade adjustment events or termination rights that may result. Clients should closely review any applicable ISDA definitional booklets that may be incorporated into trade confirmations or master confirmation agreements to address applicable issues and should note any negotiated modifications.

• Changes in Margin, Rates or Collateral Requirements: Participants should closely review their brokerage and counterparty agreements to see if the occurrence of any events could permit a counterparty to change key margining or collateral requirement terms of the arrangement or early terminate trades.

• • Monitor CDS spreads of brokers: Review term margin arrangements (lock-ups) to determine under what circumstances a broker may make modifications to the terms without the required prior notice contemplated under the arrangement; assess whether a broker can increase margin requirements or other rates that result from a widening of CDS spreads.

• • Optional Early Termination Rights: If requirements or rates are increased, firms should review whether there are any optional early termination provisions to exit a trade if they become less attractive from a pricing or margining perspective (or, in the absence of optional early termination provisions, consider whether it makes sense to negotiate exiting a trade).

• Termination Rights/Supercollateralization Rights: Review any termination or similar events applicable to the firm or the counterparty that would permit a party to terminate the arrangement.

• • Net Asset Value (“NAV”) decline triggers: Firms should be monitoring their NAV levels and, if triggers are hit, should notify and coordinate with dealer credit teams to seek waivers/amendments to NAV-related terms.

• • Credit Rating/CDS spread triggers: As a part of the ongoing review of counterparty credit risk issues, firms should continue to monitor credit ratings and CDS spreads of counterparties to assess whether any termination or other events would be triggered by such issues.

• Counterparty Credit Risk Generally: As noted above for CDS spreads/credit rating issues, firms should continue to monitor the overall financial stability and credit health indicators of their brokers and trading counterparties and employ asset protection techniques where possible (e.g., use of custodial relationships for fully paid assets/cash, excess cash sweeps, counterparty and broker diversification procedures, rehypothecation limits and enhanced reporting, etc.).

We understand that these are challenging times for our clients and friends. Kleinberg Kaplan has been diligently monitoring the updates and developments pertaining to COVID-19 and the potential impact for our clients. We will continue to provide updates as the situation develops.