What Are the Key Documentation Requirements When Executing a Close-Out Amount Calculation under the 2002 Agreement?

Concept

Executing a close-out amount calculation under the 2002 ISDA Master Agreement is an exercise in constructing a fortress of evidence. The entire process is architected around a single, dominant principle ▴ the creation of a definitive, auditable, and legally defensible record of losses or gains. Every document required serves this end, contributing to a final calculation that can withstand intense scrutiny. The central nervous system of this process is the shift within the 2002 Agreement to a purely objective standard of commercial reasonableness, a departure from the more subjective standards of its predecessor.

This operational framework demands that the designated Determining Party, which is the Non-defaulting Party in an Event of Default scenario, does more than simply arrive at a number. It must meticulously document the methodology, inputs, and procedures used to produce that number. The required documentation functions as the structural support for the final Close-Out Amount, proving that the calculation was performed not just in good faith, but in accordance with observable market realities and rational commercial practice. This system acknowledges the contentious nature of termination payments and preemptively arms the Determining Party with the necessary proof to validate its claim.

The core function of the documentation is to build an unimpeachable case for the commercial reasonableness of the final calculated amount.

Understanding the distinction between the components of the final sum is fundamental. The process involves calculating a “Close-out Amount” for each terminated transaction or group of transactions. These individual amounts, which represent the cost of replacing the economic equivalent of the terminated trades, are then aggregated with any “Unpaid Amounts” (i.e. payments that were due but not made prior to termination).

The resulting figure is the “Early Termination Amount,” the single net figure payable by one party to the other. The documentation must support not only the individual replacement cost calculations but also the final aggregation into this single, all-encompassing debt obligation.

The Determining Party’s Mandate

The 2002 ISDA Agreement places a significant burden of proof on the party making the calculation. This party must operate as a neutral executor of a prescribed process, even while acting to protect its own financial interests. The documentation is the primary output of this mandate, demonstrating adherence to the agreement’s stringent requirements.

The key documentation requirements are not arbitrary administrative hurdles; they are the very mechanisms that lend legitimacy and enforceability to the close-out process itself. Without this documented evidence, the calculation is merely an assertion, vulnerable to challenge and judicial reinterpretation.

The entire architecture of the 2002 ISDA close-out provision is designed to produce a result that is fair and grounded in market reality. The documentation serves as the bridge between the abstract requirement of “commercial reasonableness” and the concrete, calculated financial outcome. Each piece of evidence, from third-party quotes to internal data logs, forms a part of this bridge, ensuring its structural integrity.

Strategy

The strategic objective in documenting a close-out calculation is to preemptively neutralize any potential challenge by creating a record so robust and transparent that it proves the “commercial reasonableness” of the outcome as a matter of objective fact. The 2002 ISDA framework moves the standard from a subjective assessment of what a party “reasonably determines” to an objective test of whether the procedures used were commercially reasonable and produced a commercially reasonable result. This shift dictates the entire documentation strategy, which must be built around evidence and process rather than internal judgment alone.

What Is the Standard of Commercial Reasonableness?

The concept of “commercial reasonableness” is the battlefield on which close-out disputes are fought. A successful documentation strategy ensures victory on this ground. The standard requires the Determining Party to use procedures that are, in themselves, commercially sound and that also generate a result that is defensible. This can be demonstrated by showing the process was aligned with recognized market practices.

The strategy is to leave no part of the calculation process undocumented or justified solely by internal opinion. Every step must be backed by external, verifiable data where possible, and where internal data is used, its application must be rigorously defended.

The strategic selection of valuation inputs is a critical component. The 2002 Agreement provides flexibility, but this flexibility comes with responsibility. The Determining Party must document not only the data it used but also why it chose that data. For instance, if readily available third-party quotes are ignored in favor of an internal model, the documentation must provide a compelling, good-faith justification for this decision, such as demonstrating that the external quotes were not commercially reasonable.

Valuation Input Strategy and Documentation

The choice of inputs to the valuation model is a key strategic decision that must be meticulously documented. The 2002 ISDA Agreement allows for a range of information sources, each with its own strategic implications and documentation requirements.

The Finality of the Section 6(D) Statement

A crucial element of the strategy involves understanding the legal gravity of issuing the termination statement. Once the Determining Party delivers the Section 6(d) statement detailing the Early Termination Amount, it creates a binding payment obligation. This act is contractually significant and generally irreversible on a unilateral basis. If an error is discovered after the fact, the party cannot simply withdraw the statement and issue a new one.

Any correction becomes a matter for bilateral agreement or court intervention. Therefore, the pre-issuance documentation and verification strategy is paramount. All calculations must be thoroughly checked, and all supporting evidence must be compiled before the notice is sent. The strategy is one of “measure twice, cut once,” recognizing that the issuance of the statement is the point of no return.

Execution

The execution phase of a close-out calculation is a disciplined, procedural undertaking. It translates the strategic requirement for a defensible, evidence-based calculation into a tangible set of documents and actions. The primary goal is to assemble a complete and unassailable file ▴ a “Close-Out Dossier” ▴ that chronicles every step from the initial default event to the final demand for payment. This dossier is the physical manifestation of the commercially reasonable process mandated by the 2002 ISDA Master Agreement.

The Operational Documentation Checklist

A systematic approach is essential to ensure all requirements are met. The following checklist outlines the critical documentation that must be created and compiled during the close-out process. Each item represents a vital piece of the evidentiary trail.

1. Event of Default Verification File This file establishes the legal basis for the termination. It must contain definitive proof of the Event of Default that triggered the close-out. This could include records of failed payments, public announcements of bankruptcy proceedings, or correspondence related to a breach of agreement.
2. Termination Notice (Section 6(a) Notice) This is the formal written communication that initiates the process. A copy of the notice sent to the Defaulting Party, along with proof of delivery, is required. The notice must clearly state the Event of Default and specify the designated Early Termination Date.
3. Close-Out Calculation Support Dossier This is the core of the documentation. It contains all the evidence supporting the calculation of the individual Close-Out Amounts. It must be organized, detailed, and directly tied to the calculations performed. This dossier is the primary defense against any subsequent challenge.
4. The Section 6(d) Net Termination Statement This is the final, formal statement of the calculated Early Termination Amount. It must be drafted with precision, incorporating the aggregated Close-Out Amounts and any Unpaid Amounts. A copy of the final, delivered statement is the capstone of the documentation file.
5. Communications Log A detailed log of all communications with the Defaulting Party, third-party dealers, and any other relevant entities should be maintained throughout the process. This includes emails, recorded phone calls, and meeting notes, all time-stamped and dated.

How Do You Construct the Calculation Support Dossier?

The strength of the entire close-out rests on the quality of this dossier. It must provide a clear, auditable path from the raw valuation inputs to the final Close-Out Amount for each terminated transaction. The contents must be tailored to the specific type of transactions being closed out.

The dossier must be assembled as if it were an exhibit for a court proceeding, with every assertion backed by clear evidence.

The following table provides examples of the specific data and documentation required for different types of derivative transactions to be included in the dossier.

Drafting and Issuing the Section 6(D) Statement

The final step in the execution process is the delivery of the Section 6(d) statement. This document must be unambiguous. It should contain:

• Clear Identification ▴ Full legal names of the Defaulting Party and the Non-defaulting Party.
• Agreement Reference ▴ A clear reference to the 2002 ISDA Master Agreement and the date it was executed.
• Statement of Amount ▴ The final, netted Early Termination Amount, clearly stating which party is obligated to pay.
• Supporting Ledger ▴ A summary ledger showing the aggregation of the individual Close-Out Amounts and Unpaid Amounts that constitute the final Early Termination Amount.
• Payment Instructions ▴ Clear details for the payment, including bank account information and a due date as specified in the agreement.

Before this statement is issued, a final internal review and sign-off process is critical. Legal and financial teams should verify the calculations and the completeness of the Close-Out Dossier. The issuance of this statement crystallizes the debt, and the execution process must ensure this crystallization is based on a foundation of solid, irrefutable evidence.

Reflection

Is Your Operational Framework Ready for a Challenge?

The knowledge of the documentation requirements under the 2002 ISDA Master Agreement provides the components for a resilient close-out process. The ultimate strength of this process, however, is a function of the underlying operational architecture within an institution. The assembly of a Close-Out Dossier under duress is a test of an organization’s data governance, record-keeping discipline, and internal communication protocols.

Consider the systems that capture and store market data, the accessibility of trade-level hedging information, and the established procedures for internal model validation. Are these systems designed for the seamless retrieval of auditable, time-stamped evidence? The theoretical understanding of what is required is the blueprint.

The practical ability to execute flawlessly when a counterparty defaults is the true measure of operational readiness. The framework provided by the ISDA is a standard against which your own internal systems must be measured, refined, and ultimately trusted to perform.