# What Constitutes a "Commercially Reasonable" Procedure under the 2002 ISDA Agreement? ▴ Question

**Published:** 2025-08-22
**Categories:** Question

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## Concept

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## The Fulcrum of Good Faith in Derivatives

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) operates as the foundational text for the global over-the-counter derivatives market. Within its architecture, the concept of a “[commercially reasonable](https://prime.greeks.live/question/how-does-the-isda-master-agreement-define-commercially-reasonable-in-valuation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)” procedure serves as a critical fulcrum, particularly when market conditions deteriorate and one party must calculate a close-out amount following a default. This is the process of determining the net amount owed between two parties when their derivatives contracts are terminated prematurely. The 2002 Agreement shifted from the more prescriptive “Market Quotation” and “Loss” methods of the 1992 version to a more flexible, principle-based standard called the “Close-out Amount.” This evolution places a significant responsibility on the determining party to act in good faith and utilize procedures that are, in themselves, commercially reasonable to produce a result that is also commercially reasonable. 

> The standard of “commercially reasonable” is not a mere suggestion; it is an enforceable obligation of objective reasonableness.

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## An Objective Standard in a Subjective World

The term “commercially reasonable” is intentionally not defined with prescriptive rigidity in the 2002 [ISDA Master Agreement](https://prime.greeks.live/area/isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite). Instead, it establishes an objective standard of conduct against which a party’s actions can be measured. This means the [determining party](https://prime.greeks.live/question/what-is-the-role-of-the-calculating-party-in-determining-the-final-settlement-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)’s procedures are evaluated based on what a rational market participant would do in similar circumstances, irrespective of the determining party’s own internal models or preferences.

This objectivity is crucial for maintaining market confidence and ensuring that the close-out process is fair and transparent. The determining party must consider a range of relevant information, including third-party quotations, [market data](https://prime.greeks.live/area/market-data/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), and even its own internally generated information, provided it can be justified as part of a reasonable process.

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## Strategy

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## Navigating the Close-Out Amount Calculation

The strategic core of the “commercially reasonable” standard is most evident in the calculation of the [Close-out Amount](https://prime.greeks.live/area/close-out-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite). The 2002 ISDA [Master Agreement](https://prime.greeks.live/question/how-does-the-isda-master-agreements-single-agreement-clause-function-in-practice/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) provides a framework, not a formula, for this process. The determining party has the discretion to choose the most appropriate valuation inputs and methodologies, but this discretion is bounded by the obligation of commercial reasonableness.

This requires a strategic approach to valuation that is both defensible and transparent. The determining party must be able to demonstrate that its procedures were designed to produce a fair market value for the terminated transactions as of the [early termination](https://prime.greeks.live/area/early-termination/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) date.

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## Key Considerations in the Valuation Process

- **Market Data** ▴ The use of third-party supplied market data and quotations is a primary indicator of a commercially reasonable procedure. The [determining party should](https://prime.greeks.live/question/what-is-the-role-of-the-calculating-party-in-determining-the-final-settlement-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) solicit quotes from multiple dealers or consult recognized pricing sources to establish a credible valuation. 

- **Internal Models** ▴ While internal models can be used, they must be consistent with industry standards and validated against external market data. A heavy reliance on proprietary models without external verification may be challenged as not being commercially reasonable. 

- **Transparency** ▴ The determining [party should](https://prime.greeks.live/question/what-are-the-key-differences-between-first-party-and-third-party-cyber-insurance-coverage-in-the-context-of-an-rfp/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) maintain a clear record of the steps taken to calculate the Close-out Amount, including the data sources, methodologies, and any assumptions made. This documentation is essential for defending the reasonableness of the procedure in the event of a dispute. 

- **Consistency** ▴ The procedures used should be consistent with the party’s normal course of business for valuing similar transactions. Any deviation from standard practices must be justified by the specific circumstances of the close-out. 

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## The Interplay of Good Faith and Commercial Reasonableness

The 2002 ISDA Master Agreement explicitly links the concept of “[commercially reasonable procedures](https://prime.greeks.live/area/commercially-reasonable-procedures/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)” with the obligation to act in “[good faith](https://prime.greeks.live/area/good-faith/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite).” This means that the determining party must not only follow a reasonable process but also act with an honest and fair intention. The two concepts are intertwined; a procedure that is not conducted in good faith is unlikely to be considered commercially reasonable, and vice versa. For example, “cherry-picking” low quotes to inflate a close-out amount would violate both the duty of good faith and the standard of commercial reasonableness. 

> Good faith is the ethical compass that guides the application of commercially reasonable procedures.

The strategic implication for market participants is that they must cultivate a culture of fairness and transparency in their [derivatives](https://prime.greeks.live/area/derivatives/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) operations. This includes establishing clear internal guidelines for close-out procedures, training staff on their obligations under the ISDA Master Agreement, and ensuring that all actions are documented and justifiable. 

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## Execution

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## A Practical Guide to Commercially Reasonable Procedures

Executing a commercially reasonable close-out procedure requires a systematic and well-documented approach. The following steps provide a practical framework for determining the Close-out Amount in a manner that is consistent with the principles of the [2002 ISDA](https://prime.greeks.live/area/2002-isda/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) Master Agreement. 

- **Initial Assessment** ▴ Upon the occurrence of an event of default or [termination event](https://prime.greeks.live/area/termination-event/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), the determining party should immediately assess the portfolio of transactions to be terminated. This includes identifying the specific terms of each transaction and gathering all relevant documentation. 

- **Market Sounding** ▴ The next step is to obtain valuation data from the market. This can be done by requesting quotes from a panel of dealers, consulting independent pricing services, or accessing electronic trading platforms. The goal is to obtain a representative sample of market prices for similar transactions. 

- **Valuation And Calculation** ▴ Using the market data obtained, the determining party should calculate the replacement cost of each terminated transaction. This may involve using standard valuation models, but the inputs to these models should be derived from the market data. The individual transaction values are then aggregated to determine the overall Close-out Amount. 

- **Documentation And Notification** ▴ The entire process should be meticulously documented, including the names of the dealers contacted, the quotes received, the valuation methodologies used, and the final calculation of the Close-out Amount. The other party should then be notified of the Close-out Amount in a clear and timely manner. 

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## Illustrative Close-Out Calculation

The following table provides a simplified example of a Close-out Amount calculation for a portfolio of interest rate swaps. 

| Transaction ID | Notional Amount | Mark-to-Market Value | Source of Valuation |
| --- | --- | --- | --- |

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## Dispute Resolution and the Role of the Courts

Despite the best efforts of the determining party, disputes can still arise over the calculation of the Close-out Amount. In such cases, the courts will be called upon to determine whether the procedures used were commercially reasonable. The courts will typically consider a range of factors, including the prevailing market conditions at the time of the close-out, the availability of market data, and the practices of other market participants. The burden of proof will be on the party challenging the calculation to demonstrate that the determining party’s procedures were not commercially reasonable. 

> The ultimate arbiter of commercial reasonableness is the court, which will apply an objective standard of review.

To minimize the risk of a successful challenge, determining parties should ensure that their close-out procedures are robust, transparent, and consistent with market best practices. This includes having a clear and well-defined policy for close-outs, using a variety of valuation sources, and maintaining detailed records of all actions taken. 

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## References

- Cont, Rama. “The ISDA Master Agreement and the valuation of bilateral derivative portfolios.” Banque de France Financial Stability Review 15 (2011) ▴ 81-91.

- Fleming, Michael J. and Neel Krishnan. “The microstructure of the US Treasury market.” Handbook of Fixed Income Securities (2012) ▴ 1-34.

- Gregory, Jon. The xVA Challenge ▴ Counterparty Credit Risk, Funding, Collateral, and Capital. John Wiley & Sons, 2015.

- Hull, John C. Options, futures, and other derivatives. Pearson Education, 2022.

- Kenyon, Chris, and Roland Stamm. Discounting, Libor, CVA and Funding. Springer, 2012.

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## Reflection

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## Beyond the Letter of the Law

The concept of “commercially reasonable” procedures under the 2002 ISDA Master Agreement transcends a mere legal or contractual obligation. It is a reflection of the market’s expectation that participants will act with integrity and professionalism, even in times of stress. The flexibility of the standard is both its strength and its challenge.

It allows for the use of sound judgment and market expertise, but it also requires a commitment to fairness and transparency. Ultimately, a firm’s ability to navigate the complexities of the close-out process is a testament to the strength of its internal controls, its understanding of market dynamics, and its commitment to ethical conduct.

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## Glossary

<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">
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## 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/question/how-does-the-isda-master-agreement-define-commercially-reasonable-in-valuation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Commercially Reasonable

The ISDA agreement defines commercial reasonableness as a procedural standard for achieving a fair, objective valuation at close-out. </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/question/what-is-the-role-of-the-calculating-party-in-determining-the-final-settlement-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Determining Party

The Calculating Party is the contractually designated entity that determines a derivative's value, ensuring precise financial settlement. </a><a href="https://prime.greeks.live/area/market-data/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Market Data

Meaning ▴ Market Data comprises the real-time or historical pricing and trading information for financial instruments, encompassing bid and ask quotes, last trade prices, cumulative volume, and order book depth. </a><a href="https://prime.greeks.live/question/how-does-the-isda-master-agreements-single-agreement-clause-function-in-practice/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Master Agreement

The ISDA's Single Agreement clause is a legal protocol that unifies all transactions into one contract to enable enforceable close-out netting. </a><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/early-termination/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## 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/what-is-the-role-of-the-calculating-party-in-determining-the-final-settlement-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Determining Party Should

The Calculating Party is the contractually designated entity that determines a derivative's value, ensuring precise financial settlement. </a><a href="https://prime.greeks.live/question/what-are-the-key-differences-between-first-party-and-third-party-cyber-insurance-coverage-in-the-context-of-an-rfp/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Party Should

First-party cyber insurance covers your direct losses; third-party coverage addresses your liability for others' losses. </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">
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## 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/area/good-faith/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Good Faith

Meaning ▴ Good Faith, in a financial and operational context, denotes the adherence to honest intent and absence of fraudulent or deceptive conduct during contractual agreements and transactional processes. </a><a href="https://prime.greeks.live/area/derivatives/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A central, blue-illuminated, crystalline structure symbolizes an institutional grade Crypto Derivatives OS facilitating RFQ protocol execution. Diagonal gradients represent aggregated liquidity and market microstructure converging for high-fidelity price discovery, optimizing multi-leg spread trading for digital asset options](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-execution-engine-11.jpg)

## Derivatives

Meaning ▴ Derivatives are financial contracts whose value is contingent upon an underlying asset, index, or reference rate. </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">
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## 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/termination-event/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A central teal sphere, representing the Principal's Prime RFQ, anchors radiating grey and teal blades, signifying diverse liquidity pools and high-fidelity execution paths for digital asset derivatives. Transparent overlays suggest pre-trade analytics and volatility surface dynamics](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-and-market-microstructure.jpg)

## Termination Event

Meaning ▴ A Termination Event denotes a pre-specified condition or set of criteria, contractually defined or algorithmically encoded, whose verified occurrence mandates the immediate cessation or unwinding of a financial agreement, especially prevalent within institutional digital asset derivatives. </a>

**Tags:** [2002 ISDA](https://options.greeks.live/area/2002-isda/), [Early Termination](https://options.greeks.live/area/early-termination/), [OTC Derivatives](https://options.greeks.live/area/otc-derivatives/), [Derivatives](https://options.greeks.live/area/derivatives/), [ISDA Master Agreement](https://options.greeks.live/area/isda-master-agreement/), [Good Faith](https://options.greeks.live/area/good-faith/)	

## Discover More

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### [What Are the Key Differences between the 1992 and 2002 ISDA Master Agreements regarding Termination?](https://options.greeks.live/question/what-are-the-key-differences-between-the-1992-and-2002-isda-master-agreements-regarding-termination/)
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The 2002 ISDA replaces the 1992's elective termination valuations with a single, objectively reasonable Close-out Amount.

- 
### [What Role Do Internal Valuation Models Play in a Defensible Close out Calculation?](https://options.greeks.live/question/what-role-do-internal-valuation-models-play-in-a-defensible-close-out-calculation/)
![A sophisticated institutional-grade system's internal mechanics. A central metallic wheel, symbolizing an algorithmic trading engine, sits above glossy surfaces with luminous data pathways and execution triggers. This abstract visualizes high-fidelity execution for digital asset derivatives, optimizing market microstructure and RFQ protocol efficiency within a Prime RFQ.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-engine-core.jpg)

Internal valuation models are the core system for translating market data into a defensible close-out figure under ISDA protocols.

- 
### [What Are the Key Differences in the Events of Default between the 1992 and 2002 ISDA Agreements?](https://options.greeks.live/question/what-are-the-key-differences-in-the-events-of-default-between-the-1992-and-2002-isda-agreements/)
![Angular, transparent forms in teal, clear, and beige dynamically intersect, embodying a multi-leg spread within an RFQ protocol. This depicts aggregated inquiry for institutional liquidity, enabling precise price discovery and atomic settlement of digital asset derivatives, optimizing market microstructure.](https://options.greeks.live/wp-content/uploads/2025/07/multi-leg-digital-asset-derivatives-rfq-protocol-aggregation-dynamics.jpg)

The 2002 ISDA Agreement enhances counterparty risk management by introducing more precise default triggers and a commercially reasonable close-out process.

- 
### [How Does the 2002 Isda Master Agreement Change the Standard for Calculating Close out Amounts?](https://options.greeks.live/question/how-does-the-2002-isda-master-agreement-change-the-standard-for-calculating-close-out-amounts-2/)
![A precise, multi-layered disk embodies a dynamic Volatility Surface or deep Liquidity Pool for Digital Asset Derivatives. Dual metallic probes symbolize Algorithmic Trading and RFQ protocol inquiries, driving Price Discovery and High-Fidelity Execution of Multi-Leg Spreads within a Principal's operational framework.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-grade-rfq-protocol-mechanism-for-digital-asset-derivatives-price-discovery-and-high-fidelity-execution-via-prime-os.jpg)

The 2002 ISDA Agreement replaces a rigid, dual-method system with a single, flexible standard based on commercial reasonableness.

- 
### [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.

- 
### [How Did the 2002 ISDA Close out Amount Calculation Differ from Prior Methods?](https://options.greeks.live/question/how-did-the-2002-isda-close-out-amount-calculation-differ-from-prior-methods/)
![Abstract geometric forms in muted beige, grey, and teal represent the intricate market microstructure of institutional digital asset derivatives. Sharp angles and depth symbolize high-fidelity execution and price discovery within RFQ protocols, highlighting capital efficiency and real-time risk management for multi-leg spreads on a Prime RFQ platform.](https://options.greeks.live/wp-content/uploads/2025/07/prime-os-optimized-rfq-execution-for-digital-asset-derivatives.jpg)

The 2002 ISDA Close-out Amount replaced rigid valuation mechanics with a flexible, commercially reasonable standard.

- 
### [What Is the Legal Standard for “Commercially Reasonable Procedures” in a Derivatives Close-Out?](https://options.greeks.live/question/what-is-the-legal-standard-for-commercially-reasonable-procedures-in-a-derivatives-close-out/)
![Detailed metallic disc, a Prime RFQ core, displays etched market microstructure. Its central teal dome, an intelligence layer, facilitates price discovery. Protruding rods signify low-latency RFQ protocol data transmission, ensuring high-fidelity execution for digital asset derivatives.](https://options.greeks.live/wp-content/uploads/2025/07/principal-operating-system-intelligence-layer-powering-digital-asset-derivatives-rfq-protocols-for-optimal-execution.jpg)

The legal standard for "commercially reasonable procedures" is an objective duty to employ a fair, verifiable, and market-based process to calculate a derivatives close-out value.

- 
### [How Has the Calculation of Close out Amounts Evolved Operationally since the 2008 Crisis?](https://options.greeks.live/question/how-has-the-calculation-of-close-out-amounts-evolved-operationally-since-the-2008-crisis/)
![Sharp, intersecting geometric planes in teal, deep blue, and beige form a precise, pointed leading edge against darkness. This signifies High-Fidelity Execution for Institutional Digital Asset Derivatives, reflecting complex Market Microstructure and Price Discovery. It embodies RFQ optimization, Capital Efficiency across Liquidity Pools, and Atomic Settlement via a Prime RFQ.](https://options.greeks.live/wp-content/uploads/2025/07/high-fidelity-digital-asset-derivatives-rfq-market-microstructure-2.jpg)

The 2008 crisis forced close-out calculations to evolve from rigid quote-based rules to a flexible, principles-based objective standard.

- 
### [What Constitutes a Commercially Reasonable Procedure under the 2002 ISDA Master Agreement?](https://options.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-under-the-2002-isda-master-agreement-2/)
![A multi-faceted crystalline structure, featuring sharp angles and translucent blue and clear elements, rests on a metallic base. This embodies Institutional Digital Asset Derivatives and precise RFQ protocols, enabling High-Fidelity Execution. Light interaction depicts Price Discovery within complex Market Microstructure, leveraging a Prime RFQ Intelligence Layer for Multi-Leg Spread optimization and Capital Efficiency.](https://options.greeks.live/wp-content/uploads/2025/07/high-fidelity-digital-asset-derivatives-rfq-market-microstructure.jpg)

A commercially reasonable procedure is an objectively verifiable valuation protocol, central to the 2002 ISDA's risk-mitigation architecture.

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---

**Original URL:** https://options.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-under-the-2002-isda-agreement/
