# How Does the Close-Out Amount in the 2002 ISDA Improve upon the 1992 Methodologies? ▴ Question

**Published:** 2025-08-01
**Categories:** Question

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## Concept

The architecture of financial markets evolves in response to systemic pressures. The transition from the 1992 International Swaps and Derivatives Association (ISDA) Master Agreement’s close-out mechanism to the 2002 Agreement’s “[Close-Out Amount](https://prime.greeks.live/area/close-out-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)” represents a critical system upgrade. This was a direct engineering response to the instabilities and value destruction observed during the market crises of the late 1990s.

The core of this evolution lies in the re-architecting of the valuation process following a [counterparty default](https://prime.greeks.live/area/counterparty-default/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), moving from a framework that permitted a high degree of subjectivity to one governed by an objective, verifiable standard of [commercial reasonableness](https://prime.greeks.live/area/commercial-reasonableness/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite). Understanding this shift requires seeing it as a fundamental change in the operating system of the over-the-counter derivatives market, one designed to enhance stability, predictability, and fairness at the precise moment the system is under maximum stress.

The 1992 [ISDA Master Agreement](https://prime.greeks.live/area/isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) provided a bifurcated and elective framework for calculating termination payments. Parties would select at the outset of their agreement between two primary valuation methodologies ▴ “Market Quotation” and “Loss”. The Market Quotation route was itself a structured process, requiring the Determining Party (typically the [non-defaulting party](https://prime.greeks.live/area/non-defaulting-party/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)) to seek quotes for replacement transactions from at least three leading market makers. The average of these quotes would then form the basis of the settlement amount.

This approach was designed to provide a measure of objective, market-based valuation. The “Loss” methodology, conversely, was a more flexible and encompassing calculation. It allowed the [Determining Party](https://prime.greeks.live/area/determining-party/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) to calculate its total losses and costs resulting from the [early termination](https://prime.greeks.live/area/early-termination/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), a figure that could include the cost of replacement trades, hedging costs, and the loss of expected profits. This provided a broader, more subjective measure of economic damages.

> The 2002 ISDA framework introduces an objective standard of commercial reasonableness to the close-out process, replacing the more subjective and fragmented methodologies of the 1992 Agreement.

Compounding this complexity, the 1992 Agreement also contained a structural choice between two payment methods known as the “First Method” and the “Second Method”. The Second Method established a principle of [two-way payments](https://prime.greeks.live/area/two-way-payments/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite). Upon termination, the net value of all transactions under the agreement would be calculated, and whichever party was out-of-the-money would pay the other. A non-[defaulting party](https://prime.greeks.live/question/how-does-the-ccp-default-waterfall-protect-non-defaulting-members/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) could find itself owing a payment to a defaulting party if the net mark-to-market value of their combined positions was in the defaulting party’s favor.

The [First Method](https://prime.greeks.live/area/first-method/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), in stark contrast, was a one-way payment provision. Under this construct, a non-defaulting party was obligated to make a payment to the defaulting party only up to the amount of its own gains. If the non-defaulting party was in-the-money on a net basis, it had no obligation to pay its counterparty. This “walk-away” clause was highly punitive and created significant asymmetric risk, as a defaulting party could be deprived of a legitimate gain. While the market overwhelmingly favored the two-way payment structure of the [Second Method](https://prime.greeks.live/question/what-are-the-second-order-risks-gamma-and-vanna-for-a-dealer-managing-a-large-collar-portfolio/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) for its inherent fairness, the existence of the First Method within the 1992 architecture represented a potential source of significant inequity and dispute.

The [2002 ISDA Master Agreement](https://prime.greeks.live/area/2002-isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) engineered a comprehensive overhaul of this system. It eliminated the elective framework of [Market Quotation](https://prime.greeks.live/area/market-quotation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) versus Loss and abolished the First Method/Second Method payment choice. In their place, it installed a single, unified methodology termed the “Close-Out Amount”. This new architecture is defined as the amount of losses or costs the Determining Party would incur, or the gains it would realize, in replacing the economic equivalent of the terminated transactions.

The defining feature of this new standard is the explicit directive embedded within its definition ▴ the Determining Party must act in good faith and use “[commercially reasonable procedures](https://prime.greeks.live/area/commercially-reasonable-procedures/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) in order to produce a [commercially reasonable result](https://prime.greeks.live/question/how-do-courts-interpret-commercially-reasonable-procedures-in-close-out-amount-calculations/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)”. This language marks a profound shift. The previous framework allowed for a determination that could be defended as “rational” from the perspective of the Determining Party. The 2002 standard elevates this requirement to a test of objective commercial reasonableness, effectively aligning the required standard with what a court would deem appropriate under the circumstances.

This change was a direct response to the weaknesses exposed in periods of market turmoil, where the subjectivity of the “Loss” calculation and the potential rigidity of “Market Quotation” could lead to outcomes that were difficult to defend and damaging to overall market confidence. The [2002 ISDA](https://prime.greeks.live/area/2002-isda/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)’s Close-Out Amount provides a more flexible, yet more disciplined, operational protocol designed to achieve a result that is fair, transparent, and robust even in the most challenging market conditions.

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## Strategy

The strategic impetus behind the development of the 2002 ISDA’s Close-Out Amount methodology was the imperative to build a more resilient and predictable market infrastructure. The financial crises of the late 1990s, particularly the collapse of Long-Term Capital Management (LTCM), exposed critical flaws in the existing architecture for managing counterparty defaults. Regulators and market participants recognized that the ambiguity and potential for dispute inherent in the 1992 ISDA’s close-out provisions could act as an accelerant in a crisis.

A single default could trigger a cascade of terminations, and if the valuation of those terminations was itself uncertain and contentious, the resulting liquidity drain and legal battles could amplify systemic risk. The strategy, therefore, was to re-engineer the close-out process from a potentially adversarial exercise into a more standardized, transparent, and commercially grounded procedure.

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## How Does Objectivity Reshape Counterparty Risk Strategy?

The core strategic shift embedded in the 2002 ISDA is the elevation of objectivity as the governing principle of the close-out process. Under the 1992 “Loss” method, a non-defaulting party had considerable latitude in its calculations. While it could not act arbitrarily, its determination needed only to be “rational.” This created a strategic hazard. A firm’s internal model for calculating loss might be rational from its own perspective but appear punitive or opaque to its counterparty and, potentially, to a court.

This subjectivity created uncertainty, which in financial markets translates directly into risk and cost. A counterparty would have to price the risk that, in a default scenario, the valuation of its positions would be subject to the discretionary, and potentially aggressive, calculations of its opponent.

The 2002 Agreement’s mandate for “[commercially reasonable](https://prime.greeks.live/area/commercially-reasonable/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) procedures” to achieve a “commercially reasonable result” fundamentally alters this dynamic. It forces the Determining Party to adopt a valuation strategy that is defensible not just internally, but to the market at large. This means that its procedures must be transparent, based on observable market data where possible, and consistent with standard industry practices.

The strategic benefit is a significant reduction in valuation uncertainty. This, in turn, has several positive effects on [risk management](https://prime.greeks.live/area/risk-management/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) strategy:

- **Reduced Dispute Risk** ▴ By anchoring the valuation in objective commercial practice, the 2002 framework lowers the probability of protracted and costly legal disputes over close-out amounts. This frees up legal and operational resources and allows for a quicker, more efficient resolution of a default.

- **Improved Credit Pricing** ▴ With greater certainty around the recovery process in a default, the pricing of counterparty credit risk becomes more precise. The “discretion risk” inherent in the 1992 “Loss” method is substantially mitigated, allowing for more accurate credit valuation adjustments (CVA).

- **Enhanced Market Stability** ▴ A standardized, objective valuation process prevents fire-sale mentalities and aggressive, self-serving calculations during a crisis. It promotes a more orderly unwinding of positions, which helps to contain the contagion effects of a major default.

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## A Comparative Analysis of Strategic Frameworks

The strategic differences between the 1992 and 2002 frameworks can be systematically evaluated across several key performance indicators for a derivatives operating system.

| Strategic Parameter | 1992 ISDA Framework (Loss/Market Quotation) | 2002 ISDA Framework (Close-Out Amount) |
| --- | --- | --- |
| Valuation Certainty | Lower. “Loss” is subjective and opaque. “Market Quotation” can be rigid and unavailable in illiquid markets. | Higher. The standard of “commercial reasonableness” creates a predictable and defensible valuation corridor. |
| Operational Simplicity | Lower. The need to elect between Loss/Market Quotation and First/Second Method created complexity and potential for basis risk between different agreements. | Higher. A single, unified methodology simplifies documentation, negotiation, and execution of close-outs. |
| Fairness and Equity | Potentially lower. The existence of the “First Method” (one-way payment) created significant inequity, even if rarely used. | Higher. The mandatory two-way payment system ensures that a net gain is paid to the defaulting party, upholding the principle of preventing unjust enrichment. |
| Dispute Potential | Higher. The subjectivity of “Loss” and the potential for failed “Market Quotation” processes were frequent sources of litigation. | Lower. While not immune to dispute, the objective standard provides a clearer basis for resolution and discourages unreasonable claims. |
| Adaptability to Market Stress | Lower. The “Market Quotation” method proved brittle during crises when market makers might refuse to provide quotes. | Higher. The framework is flexible, allowing the use of various information sources, including internal models, as long as the overall procedure is commercially reasonable. |

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## The Strategic Elimination of Punitive Clauses

The decision to completely remove the “First Method” from the 2002 ISDA was a profound strategic statement about the maturation of the derivatives market. The First Method was a relic of an earlier, more predatory era of finance. Its logic was purely punitive ▴ it sought to penalize a defaulting party beyond its actual economic loss by allowing the non-defaulting party to retain a windfall. This approach was strategically unsound for a global market seeking stability and depth.

It discouraged participation by creating an unhedgeable risk and undermined the fundamental legal principle that damages should be compensatory, not punitive. By mandating two-way payments, the 2002 ISDA strategically aligned the derivatives market with modern commercial principles, fostering greater trust and participation. This change recognized that in a deeply interconnected financial system, the stability of the whole is more valuable than the punitive advantage of a single participant in an isolated default.

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## Execution

The execution of a close-out under the 2002 ISDA Master Agreement is a disciplined, multi-stage process governed by the central directive of achieving a commercially reasonable result. This process transforms the close-out from a potentially contentious negotiation into a structured valuation exercise. For a derivatives trading desk, a clear understanding of this operational protocol is essential for managing risk and ensuring compliance. The execution phase is where the theoretical standard of “commercial reasonableness” is translated into a concrete, auditable set of actions and calculations.

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## What Constitutes a Commercially Reasonable Procedure in Practice?

The 2002 ISDA refrains from prescribing a rigid, exhaustive list of required procedures. This flexibility is intentional, designed to allow the framework to adapt to different transaction types, market conditions, and evolving industry practices. However, Section 14 of the agreement provides a non-exhaustive list of information sources that a Determining Party may consider, which in practice forms the bedrock of a commercially reasonable procedure. The execution of the calculation involves a systematic approach to gathering, evaluating, and synthesizing this information.

An operational playbook for a Determining Party would involve the following core steps:

- **Initial Assessment and Grouping** ▴ Immediately following an Early Termination Date, the Determining Party must identify all Terminated Transactions. It may group these transactions for valuation purposes, for example, by asset class, currency, or product type, if doing so is commercially reasonable. This allows for more efficient valuation, such as calculating the net risk exposure of a portfolio of interest rate swaps rather than valuing each one in isolation.

- **Information Gathering** ▴ The party then embarks on a comprehensive information-gathering exercise. The objective is to build a robust data set from which to derive a replacement cost or gain. This process should be documented meticulously. Key sources include:

<li>**Third-Party Quotations** ▴ The party should solicit quotes for replacement transactions from active dealers in the relevant market. Unlike the 1992 [Market Quotation method](https://prime.greeks.live/question/what-are-the-practical-difficulties-of-applying-the-market-quotation-method/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), there is no strict requirement for a specific number of quotes. The focus is on the quality and relevance of the quotes obtained.

- **Relevant Market Data** ▴ This includes information from any source the party deems relevant, such as electronic trading platforms, inter-dealer broker screens, exchange-traded futures or options prices that can be used as a pricing proxy, and consensus pricing services.

- **Internal Information** ▴ The party can use its own [internal models](https://prime.greeks.live/area/internal-models/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) and data to value the terminated transactions. This is a crucial element of flexibility. However, the models used must be consistent with those used for internal risk management and financial reporting, and their outputs must be justifiable as commercially reasonable.

</li>
- **Valuation and Calculation** ▴ Using the gathered information, the Determining Party calculates the replacement value for each transaction or group of transactions. This is a “future-looking” calculation, meaning it considers the payments and obligations that would have occurred after the Early Termination Date. The calculation must also account for the creditworthiness of the Determining Party, as this would affect the price of a replacement transaction. The result is a series of positive numbers (losses or costs) and negative numbers (gains) for each Terminated Transaction.

- **Aggregation and Final Determination** ▴ The individual Close-Out Amounts are then aggregated. This sum is combined with any “Unpaid Amounts” (payments that were due but not made prior to the termination date) to arrive at the final “[Early Termination Amount](https://prime.greeks.live/area/early-termination-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite),” which is the net figure payable by one party to the other.

- **Documentation and Notification** ▴ The Determining Party must provide a statement to the other party detailing the calculations. This statement should be sufficiently detailed to show how the Early Termination Amount was calculated, including the sources of data used. This transparency is a key part of demonstrating that the process was commercially reasonable.

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## Can Internal Models Be Used in the Calculation?

Yes, the use of internal models is explicitly permitted and is one of the key improvements in the 2002 ISDA’s execution framework. The 1992 “Market Quotation” method could fail in a stressed market if dealers were unwilling or unable to provide quotes. The 2002 framework provides a vital fallback by allowing the Determining Party to use its own information, including proprietary pricing models. However, this flexibility comes with a significant responsibility.

The models must be robust, used consistently in the normal course of business, and their outputs must stand up to the test of commercial reasonableness. A firm cannot simply invent a model post-default that produces an advantageous result. The use of internal models will be considered commercially reasonable if the models are a part of the firm’s established risk management architecture and their inputs are, where possible, calibrated to observable market parameters.

> The Close-Out Amount methodology provides a flexible and robust execution framework that allows for the use of diverse information sources to arrive at a fair value.

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## Simulated Close-Out Calculation of an Interest Rate Swap Portfolio

To illustrate the execution, consider a bank (Determining Party) closing out a portfolio of five USD interest rate swaps with a defaulted hedge fund. The bank would construct a valuation file similar to the one below.

| Transaction ID | Notional (USD) | Maturity | Mark-to-Market (Internal Model) | Dealer Quote 1 (Replacement Cost) | Dealer Quote 2 (Replacement Cost) | Final Close-Out Amount (USD) |
| --- | --- | --- | --- | --- | --- | --- |
| IRS-001 | 100,000,000 | 5Y | +1,250,000 | +1,280,000 | +1,240,000 | -1,256,667 |
| IRS-002 | 50,000,000 | 10Y | -2,100,000 | -2,050,000 | -2,120,000 | +2,090,000 |
| IRS-003 | 200,000,000 | 2Y | +350,000 | +360,000 | +345,000 | -351,667 |
| IRS-004 | 75,000,000 | 7Y | -500,000 | -480,000 | -510,000 | +496,667 |
| IRS-005 | 25,000,000 | 30Y | +1,500,000 | (No Quote) | (No Quote) | -1,500,000 |

In this simulation, for the first four swaps, the bank uses an average of the two dealer quotes it obtained, blended with its own internal MTM as a reasonableness check. The final amount reflects the bank’s gain (negative number) or loss (positive number). For IRS-005, a long-dated and illiquid swap, no dealer quotes were available. Here, the bank relies on its internal model valuation, a procedure permitted under the 2002 ISDA, provided the model is commercially reasonable.

The sum of the “Final Close-Out Amount” column would then be combined with any Unpaid Amounts to determine the [final Early Termination Amount](https://prime.greeks.live/question/what-are-the-primary-differences-in-the-calculation-of-early-termination-payments/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) payable between the parties. This structured, evidence-based execution is the hallmark of the 2002 ISDA’s superior design.

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## References

- Walker Morris. “ISDA Master Agreements and the calculation of close-out payments.” 19 April 2018.

- International Comparative Legal Guides. “Derivatives Laws and Regulations Close-out Under the 1992 and 2002 ISDA Master Agreements 2025.” 17 June 2025.

- The Jolly Contrarian. “ISDA Comparison.” 24 September 2020.

- The Jolly Contrarian. “Close-out Amount – ISDA Provision.” 14 August 2024.

- PricewaterhouseCoopers. “The ISDA Master Agreements.” Legal N.D.

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## Reflection

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## Integrating the New Standard

The transition from the 1992 to the 2002 ISDA framework was more than a mere textual update; it was a fundamental upgrade to the market’s operating system for risk. The principles of objectivity, transparency, and commercial reasonableness are not abstract legal concepts. They are active parameters within your firm’s risk management architecture. How does your current operational playbook for counterparty default align with this modern standard?

Does your valuation methodology rely on a robust, documented, and consistent process capable of withstanding external scrutiny? The knowledge of this evolution is a component of a larger system of institutional intelligence. The ultimate strategic advantage lies in ensuring your internal protocols are not just compliant with, but are a seamless expression of, the market’s most resilient design.

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## Glossary

<a href="https://prime.greeks.live/area/close-out-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Close-Out Amount

Meaning ▴ The Close-Out Amount represents the definitive financial value required to terminate a derivatives contract or position, typically calculated upon a default event or a pre-defined termination trigger. </a><a href="https://prime.greeks.live/area/commercial-reasonableness/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Commercial Reasonableness

Meaning ▴ Commercial reasonableness refers to the standard by which a transaction or action is judged to be consistent with prevailing market practices, industry norms, and sound business judgment, particularly concerning pricing, terms, and execution methodology. </a><a href="https://prime.greeks.live/area/counterparty-default/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A central dark nexus with intersecting data conduits and swirling translucent elements depicts a sophisticated RFQ protocol's intelligence layer. This visualizes dynamic market microstructure, precise price discovery, and high-fidelity execution for institutional digital asset derivatives, optimizing capital efficiency and mitigating counterparty risk](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-engine-visualizing-high-fidelity-execution-and-market-microstructure-dynamics.jpg)

## Counterparty Default

Meaning ▴ Counterparty Default refers to the failure of a party to a financial transaction to fulfill its contractual obligations, such as delivering assets, making payments, or settling positions. </a><a href="https://prime.greeks.live/area/isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Isda Master Agreement

Meaning ▴ The ISDA Master Agreement is a standardized contractual framework for privately negotiated over-the-counter (OTC) derivatives transactions, establishing common terms for a wide array of financial instruments. </a><a href="https://prime.greeks.live/area/non-defaulting-party/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Non-Defaulting Party

Meaning ▴ The Non-Defaulting Party designates the entity within a bilateral or multilateral contractual agreement, particularly in digital asset derivatives, that remains in full compliance with its obligations and terms when a counterparty fails to meet its own, thereby triggering a default event. </a><a href="https://prime.greeks.live/area/determining-party/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Sleek, modular system component in beige and dark blue, featuring precise ports and a vibrant teal indicator. This embodies Prime RFQ architecture enabling high-fidelity execution of digital asset derivatives through bilateral RFQ protocols, ensuring low-latency interconnects, private quotation, institutional-grade liquidity, and atomic settlement](https://options.greeks.live/wp-content/uploads/2025/07/prime-os-rfq-system-interface-for-digital-asset-derivatives-execution.jpg)

## Determining Party

Meaning ▴ The Determining Party is the designated entity, system component, or algorithmic agent possessing the final and binding authority to initiate, validate, or conclude a specific event, transaction, or state transition within a defined operational framework. </a><a href="https://prime.greeks.live/area/early-termination/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Intersecting digital architecture with glowing conduits symbolizes Principal's operational framework. An RFQ engine ensures high-fidelity execution of Institutional Digital Asset Derivatives, facilitating block trades, multi-leg spreads](https://options.greeks.live/wp-content/uploads/2025/07/principal-digital-asset-derivatives-rfq-engine-high-fidelity-execution.jpg)

## Early Termination

Meaning ▴ A contractual provision or systemic mechanism enabling pre-scheduled cessation of a derivative instrument or financial agreement prior to its original maturity. </a><a href="https://prime.greeks.live/question/how-does-the-ccp-default-waterfall-protect-non-defaulting-members/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A complex, multi-layered electronic component with a central connector and fine metallic probes. This represents a critical Prime RFQ module for institutional digital asset derivatives trading, enabling high-fidelity execution of RFQ protocols, price discovery, and atomic settlement for multi-leg spreads with minimal latency](https://options.greeks.live/wp-content/uploads/2025/08/institutional-digital-asset-rfq-engine-driving-best-execution-and-liquidity.jpg)

## Defaulting Party

A CCP's default waterfall shields non-defaulting members by sequentially activating layers of financial resources to absorb and contain a defaulter's losses. </a><a href="https://prime.greeks.live/area/two-way-payments/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A metallic, circular mechanism, a precision control interface, rests on a dark circuit board. This symbolizes the core intelligence layer of a Prime RFQ, enabling low-latency, high-fidelity execution for institutional digital asset derivatives via optimized RFQ protocols, refining market microstructure](https://options.greeks.live/wp-content/uploads/2025/08/precision-rfq-protocol-engine-for-institutional-digital-asset-derivatives.jpg)

## Two-Way Payments

Meaning ▴ Two-way payments represent a financial mechanism enabling bidirectional value transfer between two distinct entities or accounts within a single established channel. </a><a href="https://prime.greeks.live/question/what-are-the-second-order-risks-gamma-and-vanna-for-a-dealer-managing-a-large-collar-portfolio/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A layered, spherical structure reveals an inner metallic ring with intricate patterns, symbolizing market microstructure and RFQ protocol logic. A central teal dome represents a deep liquidity pool and precise price discovery, encased within robust institutional-grade infrastructure for high-fidelity execution](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-prime-os-orchestrating-rfq-protocols-for-high-fidelity-execution-and-multi-asset-liquidity.jpg)

## Second Method

A dealer's second-order risks in a collar are the costs of managing the instability of their primary directional and volatility hedges. </a><a href="https://prime.greeks.live/area/first-method/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A polished metallic needle, crowned with a faceted blue gem, precisely inserted into the central spindle of a reflective digital storage platter. This visually represents the high-fidelity execution of institutional digital asset derivatives via RFQ protocols, enabling atomic settlement and liquidity aggregation through a sophisticated Prime RFQ intelligence layer for optimal price discovery and alpha generation](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-optimization-for-high-fidelity-execution-and-liquidity-aggregation-via-prime-os-intelligence-layer.jpg)

## First Method

Meaning ▴ The "First Method" denotes the default or primary execution algorithm configured within an institutional digital asset trading system, representing a highly optimized, low-latency pathway designed for standard order flow. </a><a href="https://prime.greeks.live/area/2002-isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A sleek, light interface, a Principal's Prime RFQ, overlays a dark, intricate market microstructure. This represents institutional-grade digital asset derivatives trading, showcasing high-fidelity execution via RFQ protocols](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-prime-os-execution-system.jpg)

## 2002 Isda Master Agreement

Meaning ▴ The 2002 ISDA Master Agreement represents a standardized bilateral contractual framework for over-the-counter (OTC) derivatives transactions. </a><a href="https://prime.greeks.live/area/market-quotation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A specialized hardware component, showcasing a robust metallic heat sink and intricate circuit board, symbolizes a Prime RFQ dedicated hardware module for institutional digital asset derivatives. It embodies market microstructure enabling high-fidelity execution via RFQ protocols for block trade and multi-leg spread](https://options.greeks.live/wp-content/uploads/2025/08/prime-os-dedicated-hardware-for-institutional-rfq-execution.jpg)

## Market Quotation

Meaning ▴ A market quotation represents the current executable bid and ask prices for a specific financial instrument, typically accompanied by the corresponding tradable sizes or market depth at various price levels. </a><a href="https://prime.greeks.live/area/commercially-reasonable-procedures/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Abstract geometric design illustrating a central RFQ aggregation hub for institutional digital asset derivatives. Radiating lines symbolize high-fidelity execution via smart order routing across dark pools](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-high-fidelity-execution-architecture.jpg)

## Commercially Reasonable Procedures

Meaning ▴ Commercially Reasonable Procedures defines the standard of conduct for actions taken within a financial context, mandating diligence and adherence to prevailing market practices and conditions. </a><a href="https://prime.greeks.live/question/how-do-courts-interpret-commercially-reasonable-procedures-in-close-out-amount-calculations/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Detailed metallic disc, a Prime RFQ core, displays etched market microstructure. Its central teal dome, an intelligence layer, facilitates price discovery](https://options.greeks.live/wp-content/uploads/2025/07/principal-operating-system-intelligence-layer-powering-digital-asset-derivatives-rfq-protocols-for-optimal-execution.jpg)

## Commercially Reasonable Result

Courts interpret "commercially reasonable procedures" as an objective, evidence-based standard for valuing derivative close-outs. </a><a href="https://prime.greeks.live/area/2002-isda/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Abstract forms depict interconnected institutional liquidity pools and intricate market microstructure. Sharp algorithmic execution paths traverse smooth aggregated inquiry surfaces, symbolizing high-fidelity execution within a Principal's operational framework](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-microstructure-prime-os-1.jpg)

## 2002 Isda

Meaning ▴ The 2002 ISDA Master Agreement constitutes a standardized contractual framework, widely adopted within the over-the-counter (OTC) derivatives market, establishing foundational terms for bilateral derivatives transactions. </a><a href="https://prime.greeks.live/area/commercially-reasonable/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A multi-faceted digital asset derivative, precisely calibrated on a sophisticated circular mechanism. This represents a Prime Brokerage's robust RFQ protocol for high-fidelity execution of multi-leg spreads, ensuring optimal price discovery and minimal slippage within complex market microstructure, critical for alpha generation](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-execution-precision-2.jpg)

## Commercially Reasonable

Meaning ▴ Commercially Reasonable refers to actions, terms, or conditions that a prudent party would undertake or accept in a similar business context, aiming to achieve a desired outcome efficiently and effectively while considering prevailing market conditions, industry practices, and available alternatives. </a><a href="https://prime.greeks.live/area/risk-management/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![An Institutional Grade RFQ Engine core for Digital Asset Derivatives. This Prime RFQ Intelligence Layer ensures High-Fidelity Execution, driving Optimal Price Discovery and Atomic Settlement for Aggregated Inquiries](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-engine-core-high-fidelity.jpg)

## Risk Management

Meaning ▴ Risk Management is the systematic process of identifying, assessing, and mitigating potential financial exposures and operational vulnerabilities within an institutional trading framework. </a><a href="https://prime.greeks.live/question/what-are-the-practical-difficulties-of-applying-the-market-quotation-method/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A sleek metallic device with a central translucent sphere and dual sharp probes. This symbolizes an institutional-grade intelligence layer, driving high-fidelity execution for digital asset derivatives](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-platform-precision.jpg)

## Market Quotation Method

The market quotation method's core difficulty is its dependency on liquid, orderly markets, which fails during systemic stress. </a><a href="https://prime.greeks.live/area/internal-models/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Polished concentric metallic and glass components represent an advanced Prime RFQ for institutional digital asset derivatives. It visualizes high-fidelity execution, price discovery, and order book dynamics within market microstructure, enabling efficient RFQ protocols for block trades](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-prime-os-precision.jpg)

## Internal Models

Meaning ▴ Internal Models constitute a sophisticated computational framework utilized by financial institutions to quantify and manage various risk exposures, including market, credit, and operational risk, often serving as the foundation for regulatory capital calculations and strategic business decisions. </a><a href="https://prime.greeks.live/area/early-termination-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A metallic disc intersected by a dark bar, over a teal circuit board. This visualizes Institutional Liquidity Pool access via RFQ Protocol, enabling Block Trade Execution of Digital Asset Options with High-Fidelity Execution](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-principal-operational-framework-market-microstructure-high-fidelity-execution.jpg)

## Early Termination Amount

Meaning ▴ The Early Termination Amount represents the calculated net sum payable by one party to another upon the premature cessation of a derivatives contract or financing agreement, typically triggered by an event of default, force majeure, or other specified termination event. </a><a href="https://prime.greeks.live/question/what-are-the-primary-differences-in-the-calculation-of-early-termination-payments/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A sophisticated, multi-layered trading interface, embodying an Execution Management System EMS, showcases institutional-grade digital asset derivatives execution. Its sleek design implies high-fidelity execution and low-latency processing for RFQ protocols, enabling price discovery and managing multi-leg spreads with capital efficiency across diverse liquidity pools](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-trading-platform-market-microstructure.jpg)

## Final Early Termination Amount

The primary difference is the shift from the 1992 ISDA's rigid, quote-based rules to the 2002 ISDA's flexible, principles-based Close-out Amount. </a>

**Tags:** [Two-Way Payments](https://options.greeks.live/area/two-way-payments/), [Credit Valuation Adjustment](https://options.greeks.live/area/credit-valuation-adjustment/), [Derivatives Law](https://options.greeks.live/area/derivatives-law/), [2002 ISDA Master Agreement](https://options.greeks.live/area/2002-isda-master-agreement/), [Commercially Reasonable Procedures](https://options.greeks.live/area/commercially-reasonable-procedures/), [Commercial Reasonableness](https://options.greeks.live/area/commercial-reasonableness/)	

## Discover More

- 
### [How Does the 2002 ISDA’S Close-Out Amount Calculation Differ from the 1992 Version’s Loss Method?](https://options.greeks.live/question/how-does-the-2002-isdas-close-out-amount-calculation-differ-from-the-1992-versions-loss-method/)
![Abstract geometric forms converge at a central point, symbolizing institutional digital asset derivatives trading. This depicts RFQ protocol aggregation and price discovery across diverse liquidity pools, ensuring high-fidelity execution. The structure reflects a robust Prime RFQ optimizing capital efficiency for multi-leg spreads.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-rfq-execution-microstructure-core-liquidity-hub.jpg)

The 2002 ISDA's Close-Out Amount mandates an objective, commercially reasonable process using diverse inputs, replacing the 1992's subjective Loss calculation.

- 
### [Why Was the “First Method” or One-Way Payment System Removed in the 2002 ISDA Master Agreement?](https://options.greeks.live/question/why-was-the-first-method-or-one-way-payment-system-removed-in-the-2002-isda-master-agreement/)
![A central toroidal structure and intricate core are bisected by two blades: one algorithmic with circuits, the other solid. This symbolizes an institutional digital asset derivatives platform, leveraging RFQ protocols for high-fidelity execution and price discovery. It optimizes market microstructure for capital efficiency, managing multi-leg spreads and latent liquidity within a Principal's operational framework.](https://options.greeks.live/wp-content/uploads/2025/07/digital-asset-derivatives-rfq-execution-hub-integrating-algorithmic-intelligence-for-high-fidelity-price-discovery-and-liquidity-aggregation.jpg)

The First Method was removed to enforce equitable two-way payments, align with regulatory capital rules, and enhance overall market stability.

- 
### [How Does the 2002 ISDA Close-Out Amount Improve upon the 1992 Market Quotation Method?](https://options.greeks.live/question/how-does-the-2002-isda-close-out-amount-improve-upon-the-1992-market-quotation-method/)
![A sleek, spherical intelligence layer component with internal blue mechanics and a precision lens. It embodies a Principal's private quotation system, driving high-fidelity execution and price discovery for digital asset derivatives through RFQ protocols, optimizing market microstructure and minimizing latency.](https://options.greeks.live/wp-content/uploads/2025/08/principals-private-quotation-system-intelligence-layer-component.jpg)

The 2002 ISDA Close-Out Amount replaces a rigid polling system with a flexible, commercially reasonable standard for greater accuracy.

- 
### [How Does the 2002 Isda Master Agreement Differ from the 1992 Version regarding Close Out?](https://options.greeks.live/question/how-does-the-2002-isda-master-agreement-differ-from-the-1992-version-regarding-close-out/)
![A robust, dark metallic platform, indicative of an institutional-grade execution management system. Its precise, machined components suggest high-fidelity execution for digital asset derivatives via RFQ protocols. The textured surface implies granular market microstructure data, supporting price discovery and atomic settlement for block trades within a prime brokerage framework.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-platform-high-fidelity-price-discovery-and-atomic-settlement-infrastructure.jpg)

The 2002 ISDA Agreement replaces the 1992 version's rigid close-out methods with a flexible, commercially reasonable standard.

- 
### [What Constitutes a Commercially Reasonable Procedure in a Derivatives Close-Out?](https://options.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-in-a-derivatives-close-out/)
![A teal sphere with gold bands, symbolizing a discrete digital asset derivative block trade, rests on a precision electronic trading platform. This illustrates granular market microstructure and high-fidelity execution within an RFQ protocol, driven by a Prime RFQ intelligence layer.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivative-rfq-protocol-high-fidelity-execution-platform-microstructure-intelligence-layer.jpg)

A commercially reasonable procedure is an objective, evidence-based protocol for valuing a terminated derivative to ensure a fair result.

- 
### [What Constitutes a Commercially Reasonable Procedure in a Close-Out Scenario?](https://options.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-in-a-close-out-scenario/)
![Glowing teal conduit symbolizes high-fidelity execution pathways and real-time market microstructure data flow for digital asset derivatives. Smooth grey spheres represent aggregated liquidity pools and robust counterparty risk management within a Prime RFQ, enabling optimal price discovery.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-market-microstructure-prime-os.jpg)

A commercially reasonable procedure is a defensible, objective process for valuing terminated derivatives to ensure a fair and equitable settlement.

- 
### [What Are the Primary Differences in the Close-Out Calculation between the Two Agreements?](https://options.greeks.live/question/what-are-the-primary-differences-in-the-close-out-calculation-between-the-two-agreements/)
![Two robust, intersecting structural beams, beige and teal, form an 'X' against a dark, gradient backdrop with a partial white sphere. This visualizes institutional digital asset derivatives RFQ and block trade execution, ensuring high-fidelity execution and capital efficiency through Prime RFQ FIX Protocol integration for atomic settlement.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-optimized-execution.jpg)

The 2002 ISDA Agreement replaces the 1992's subjective rationality with an objective, commercially reasonable standard for close-out.

- 
### [How Did the Collapse of Ltcm Influence the Changes in the 2002 Isda Master Agreement?](https://options.greeks.live/question/how-did-the-collapse-of-ltcm-influence-the-changes-in-the-2002-isda-master-agreement/)
![A precision-engineered, multi-layered system visually representing institutional digital asset derivatives trading. Its interlocking components symbolize robust market microstructure, RFQ protocol integration, and high-fidelity execution. Gears and structural elements underscore atomic settlement, liquidity aggregation, and capital efficiency within a Prime RFQ framework.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocols-high-fidelity-execution-4.jpg)

The LTCM collapse forced a systemic upgrade in derivatives law, replacing rigid valuation with flexible, crisis-proof close-out mechanics.

- 
### [How Does the 2002 ISDA Master Agreement Differ from the 1992 Version regarding Netting?](https://options.greeks.live/question/how-does-the-2002-isda-master-agreement-differ-from-the-1992-version-regarding-netting/)
![A cutaway reveals the intricate market microstructure of an institutional-grade platform. Internal components signify algorithmic trading logic, supporting high-fidelity execution via a streamlined RFQ protocol for aggregated inquiry and price discovery within a Prime RFQ.](https://options.greeks.live/wp-content/uploads/2025/07/high-fidelity-execution-for-digital-asset-derivatives-via-rfq-protocols.jpg)

The 2002 ISDA Agreement enhances netting by replacing rigid valuation with a commercially reasonable standard for greater certainty.

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                "text": "The core strategic shift embedded in the 2002 ISDA is the elevation of objectivity as the governing principle of the close-out process. Under the 1992 \"Loss\" method, a non-defaulting party had considerable latitude in its calculations. While it could not act arbitrarily, its determination needed only to be \"rational.\" This created a strategic hazard. A firm's internal model for calculating loss might be rational from its own perspective but appear punitive or opaque to its counterparty and, potentially, to a court. This subjectivity created uncertainty, which in financial markets translates directly into risk and cost. A counterparty would have to price the risk that, in a default scenario, the valuation of its positions would be subject to the discretionary, and potentially aggressive, calculations of its opponent."
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                "text": "The 2002 ISDA refrains from prescribing a rigid, exhaustive list of required procedures. This flexibility is intentional, designed to allow the framework to adapt to different transaction types, market conditions, and evolving industry practices. However, Section 14 of the agreement provides a non-exhaustive list of information sources that a Determining Party may consider, which in practice forms the bedrock of a commercially reasonable procedure. The execution of the calculation involves a systematic approach to gathering, evaluating, and synthesizing this information."
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                "text": "Yes, the use of internal models is explicitly permitted and is one of the key improvements in the 2002 ISDA's execution framework. The 1992 \"Market Quotation\" method could fail in a stressed market if dealers were unwilling or unable to provide quotes. The 2002 framework provides a vital fallback by allowing the Determining Party to use its own information, including proprietary pricing models. However, this flexibility comes with a significant responsibility. The models must be robust, used consistently in the normal course of business, and their outputs must stand up to the test of commercial reasonableness. A firm cannot simply invent a model post-default that produces an advantageous result. The use of internal models will be considered commercially reasonable if the models are a part of the firm's established risk management architecture and their inputs are, where possible, calibrated to observable market parameters."
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```


---

**Original URL:** https://options.greeks.live/question/how-does-the-close-out-amount-in-the-2002-isda-improve-upon-the-1992-methodologies/
