On October 7, 2020, the International Swaps and Derivatives Association (ISDA) published model clauses for use with the 2005 ISDA Commodity Definitions (the ISDA Commodity Definitions) to address negative commodity prices for transactions that reference the ISDA Commodity Definitions.1 The model clauses arrive in the wake of this year’s historic collapse of West Texas Intermediate (WTI) crude oil futures prices, which on April 20 fell to negative $40.32 per barrel before settling at negative $37.63 per barrel at the close.2 Before the WTI collapse, the Chicago Mercantile Exchange (CME) had announced its plan to switch models for option pricing if futures for certain contracts traded at negative prices3 and also announced that it had updated its trading systems to process negative prices for exchange-traded contracts,4 but ISDA had not expressly addressed negative commodity pricing for over-the-counter trades that reference the ISDA Commodity Definitions.5 In fact, as part of its publication of the model clauses, ISDA expressly noted the “publication of the Model Clauses does not imply, and should not be construed as implying, that a negative floating amount would or would not be payable under the terms of the Commodity Definitions (absent use of one of the Model Clauses).”
The ISDA Commodity Definitions provide for a “Floating Amount” determined by reference to a designated commodity index price.6 In a typical fixed-for-floating commodity swap transaction, one party (the fixed rate payer) is required to make a payment to the other party (the floating rate payer) based on a fixed rate per unit of the applicable commodity, and the floating rate payer is required to make a payment to the fixed rate payer based on the then-current floating rate, plus or minus a spread, per unit of the applicable commodity. On each payment date, the fixed amount and floating amount are netted against each other, such that if the fixed amount exceeds the floating amount, the fixed rate payer will pay the difference to the floating rate payer and vice versa.
To address market concerns over the fact that the ISDA Commodity Definitions did not expressly address negative commodity prices, ISDA has now published the model clauses to provide two options that parties can elect to incorporate into their commodity trading documentation:
- Obligation to pay the absolute value of a negative floating amount. Under the first model clause, if the floating amount under a commodity transaction is negative, the absolute value of the negative floating amount will be payable by the party (i.e., the fixed rate payer) that would otherwise be the recipient of a positive floating amount, and the party that otherwise would have been the payer of a positive floating amount will not be required to make any payment.
- No obligation to pay the absolute value of a negative floating amount (zero floor). Under the second model clause, if the floating amount under a commodity transaction is a negative amount, the floating amount is deemed to be zero (so the fixed rate payer would be obligated to pay only the relevant fixed amount).
The new model clauses are not supplements to the ISDA Commodity Definitions and thus do not automatically amend them or other standard ISDA documentation. Instead, the model clauses are intended as sample provisions that parties can elect to incorporate into their trading documentation. Thus, parties with preexisting commodity transactions that wish to expressly address the impact of negative rates on such transactions may wish to consider amendments to their existing ISDA trading documentation to incorporate one of the model clauses. Further, parties entering into new commodity transactions may wish to consider whether one of the model clauses should be included in the trading documentation for such new transactions. Note that the template model clause language was drafted from the perspective of the ISDA Commodity Definitions and ISDA standard form of confirmations, and thus it may be necessary to adjust the model clause language to reflect other provisions in the relevant trading documentation and the desired commercial terms of a transaction as well as taking into account applicable legal, tax, and accounting considerations.
1 The model clauses are available for download at https://www.isda.org/book/model-clauses-for-commodity-negative-prices/.
2 U.S. Energy Information Administration, This Week in Petroleum, April 22, 2020, available at https://www.eia.gov/petroleum/weekly/archive/2020/200422/includes/analysis_print.php.
3 See CME Clearing Advisory Notice 20-152, April 8, 2020, https://www.cmegroup.com/content/dam/cmegroup/notices/clearing/2020/04/Chadv20-152.pdf.
4 See CME Clearing Advisory Notice 20-160, April 15, 2020, “Glutted Oil Markets’ Next Worry: Subzero Prices,” The Wall Street Journal, April 15, 2020, https://www.wsj.com/articles/glutted-oil-markets-next-worry-subzero-prices-11586943001.
5 Interestingly, the ISDA 2006 Definitions, which apply to interest rate swap transactions, contemplate the possibility of negative rates, but the ISDA Commodity Definitions do not contain the same provisions. See ISDA 2006 Definitions, Section 6.4 (Negative Interest Rates), which provides that the “Negative Interest Rate Method” will apply to all transactions under the 2006 Definitions unless the parties expressly specify otherwise.
6 2005 ISDA Commodity Definitions, Section 6.1 (Calculation of a Floating Amount).
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