Disruption Events under Structured Securities Programmes

Introduction

Structured products programmes enable issuers to issue different types of securities, where the performance and return of such securities is often contingent on, or highly sensitive to, the performance of various classes of underlying assets. The terms and conditions of such securities will generally grant specific rights to, and impose specific obligations on, both the issuer and security holders, and such rights and obligations are often triggered upon the occurrence of certain events (for example, the breach of a particular price threshold) in respect of the relevant underlying assets.

In the past five years alone, market participants have been faced with the global COVID-19 pandemic, multiple inter-state regional and political conflicts and the imposition of sanctions and tariffs by various governments (either on a unilateral basis or as part of a co-ordinated effort). These global events have had, and will continue to have, a significant impact on the performance of financial markets and the behaviour and response of market participants. In light of the above, it is crucial for issuers of structured products programmes to continually assess whether the disruption events covered by structured products programmes, and the consequential fallbacks and adjustments for these, provide adequate and workable solutions, and, to the extent that they do (or do not), determine the most commercially efficacious way to deal with the various disruption events that may arise during the lifetime of securities issued under such programmes.

This article focuses on disruption events in respect of structured securities for which the underlying assets are shares. These disruption events are generally split into two categories – short-term disruption events, which are principally temporary market disruptions (such as a trading suspension or an early closure), and long-term disruption events, which fundamentally affect the issuer's ability to deal with the relevant shares (such as an underlying share being delisted, or a change in law rendering it illegal for the issuer to buy or sell a particular share), and consequentially, to perform its valuation and payment obligations under the relevant securities. The former category of disruption events is generally addressed through valuation postponement, with the exact postponement mechanics being highly customisable in accordance with the needs of the issuer and demands of the security holders. The latter is generally addressed through provisions which grant the issuer the right to amend specific terms of the securities upon the occurrence of certain events, to redeem or exercise the securities prior to their scheduled maturity, or to propose any number of long-term solutions bearing in mind that a significant amount of time may elapse before the relevant shares are freely tradeable again. As a starting point, the International Swaps and Derivatives Association, Inc. ("ISDA") provides guidance and industry agreed solutions to address disruption events in general (albeit in the context of bilateral derivatives transactions), and many issuers have adapted the approaches and concepts published by ISDA in the 2002 ISDA Equity Derivatives Definitions (the "2002 ISDA EDD") for their own structured products programmes.

This article seeks to examine four specific examples of short- and long-term disruption events which affect the rights and obligations of issuers of share linked securities, and whether the provisions which are generally included in structured products programmes adequately deal with such disruption events. Where appropriate, improvements and drafting approaches have been proposed, in addition to any salient considerations which issuers ought to bear in mind when dealing with such disruption events. These disruption events are:

1. unscheduled holidays – a short-term disruption event which occurs when governments declare public holidays with little notice due to the occurrence of a nationally significant event;
2. trading disruptions – a short-term disruption event which occurs when an exchange imposes a suspension or limitation on trading, due to excessive price movement or otherwise;
3. the imposition of sanctions, which, depending on the exact nature of the sanctions, generally would be considered a medium- to long-term disruption event, and the possible knock-on effects of such sanctions (which may lead to further disruption); and
4. the occurrence of what are commonly termed "extraordinary events", which are events which result in long-term market disruption. Examples of such extraordinary events include mergers, tender offers, nationalisation, delisting or the insolvency of the share issuer.

Unscheduled Holidays

An "Unscheduled Holiday" is a term commonly used in financial markets, to refer to a particular day which is not a relevant business day ("business day" here being defined by reference to the relevant offering and/or issuance documentation, and the nature of the business day depending on the underlying asset in question and the determination required to be made on the relevant valuation date), where the market was not aware that such a day was not a business day until usually two business day prior to that non-business day¹. In the context of shares, Unscheduled Holidays generally result from exchanges declaring, with little warning, that they will not be operational on particular days following government guidance.

The usual practice for dealing with an exchange closure is, if announced far enough in advance, to simply treat such closure as either (a) a non-Scheduled Trading Day, or (b) a Scheduled Trading Day which is a Disrupted Day for the purposes of determining valuation and/or payment dates in respect of the securities. Generally, the former option is chosen where possible, but the latter definition can also be opted if parties have interpreted "Scheduled Trading Day" by reference to the scheduled of the relevant exchange on the trade date of that particular issuance, which quite often falls prior to the announcement of the Unscheduled Holiday.

In respect of equity-linked structured securities, it would seem that the above approach, which is also the approach suggested by ISDA (albeit in the context of bilateral derivative transactions) (the "ISDA Approach"), would ordinarily be sufficient to deal with any issues that might arise with valuation of the underlying shares. However, while the ISDA Approach works well when dealing with valuation dates that are determined in advance, it does not fare so well in situations where the calculation agent in respect of the relevant securities (the "Calculation Agent") is required to anticipate when the valuation date should fall. For example, in the Japanese financial markets, it is not uncommon for the issuer of structured securities to specify that the valuation dates for the underlying shares are to fall a certain number of Scheduled Trading Days prior to the relevant payment date. In such a situation, the Calculation Agent would have to, on an appropriate date sufficiently close to the payment date, determine when the relevant valuation date should fall. If one of the intervening Scheduled Trading Days then unexpectedly turns out to be an Unscheduled Holiday, it is possible that the appropriate valuation date retroactively falls after the date on which the Calculation Agent has to make this determination, resulting in the valuation occurring too late.

A concrete example where such a concept might come into play can be observed from Nasdaq's announcement on 30 December 2024, where Nasdaq declared that all Nasdaq US equities and options markets would be closed on 9 January 2025 to mourn the passing of former U.S. President Jimmy Carter². Let us assume that a payment was to be made on 10 January 2025, and the corresponding valuation date was scheduled to fall ten Scheduled Trading Days prior (i.e., 26 December 2024). The Calculation Agent would hence have completed the necessary valuation on 26 December 2024 (in the absence of any disruption), but once the announcement was made on 30 December 2024, 9 January 2025 would be an Unscheduled Holiday, and the correct valuation date should have been 24 December 2024.

In such a scenario, the issuer would likely have made prior booking and hedging arrangements, on the basis that 26 December 2024 would be the relevant valuation date. Clearly, it would not be possible for these arrangements to be reworked once the announcement was publicised on 30 December 2024. Furthermore, even if the announcement was made on an earlier date (e.g., 24 December 2024), the issuer may not have sufficient time to unwind and re-instate appropriate hedges, amend its internal booking systems and notify the security holders in a timely fashion. The likely consequence of this Unscheduled Holiday, then, is that the original hedging and booking arrangements are retained, which creates its own set of problems. It is very unlikely that the values of the shares taken on 24 December 2024 and 26 December 2024 would be exactly the same, and it is entirely possible that the relevant values obtained on 24 December 2024 would result in a more economically favourable outcome for security holders. The holders are likely to be aware of this, and demand that the issuer take 24 December 2024 as the actual valuation date instead for the purposes of determining the amounts payable under the securities. If the issuer agrees to this, its hedging arrangements (which were made on the basis of 26 December 2024 being the valuation date) may not adequately cover its economic exposure and it may have residual undesired economic exposure. If the issuer refuses to accede to the demands of the security holders, it has to accept possible legal and reputation risks which naturally accompany such a position.

The standard ISDA adjustments for non-Scheduled Trading Days and Disrupted Days do not adequately address this scenario. The concept of an "Unscheduled Holiday" exists in the 2021 ISDA Interest Rate Derivative Definitions, but is used primarily to address issues that may arise when using the Modified Following or Preceding Business Day Conventions. In summary, should either of the above Business Day Conventions apply, and as a consequence of which a valuation date or payment date no longer falls on a Business Day, then, notwithstanding the stipulated Business Day Convention, that valuation date or payment date would fall on the immediately following Business Day. This "Unscheduled Holiday" adjustment can be elected for in the relevant confirmation between the transacting parties. However, it is clear that the issue ISDA was attempting to address with this new concept is of little help in the scenario outlined in the previous paragraphs.

If structured securities issuers are contemplating issuing products which fit the above factual matrix (i.e., products that require the Calculation Agent to anticipate valuation dates in advance), they may therefore need to consider incorporating additional mechanics into their offering and issuance documentation which allow for the valuation dates to be "locked in" in advance, and hence minimise the risk of an Unscheduled Holiday throwing a spanner into the works. A possible solution would be to incorporate the concept of an "Expected Scheduled Trading Day", which would be defined (for the purposes of the Calculation Agent determining an appropriate valuation date) as a day which the Calculation Agent anticipates, based on the information available to it at that time, and as of the date (the anticipation date) that it has determined such valuation date should fall that the relevant exchanges are open for trading. The valuation dates could then be stipulated to fall a certain number of Expected Scheduled Trading Days prior to the relevant payment date. Phrased this way, the valuation dates would be "locked in" as of the anticipation date, and the Calculation Agent would not have the obligation to amend the date determined to be the valuation date, even if it later transpired that a day that was originally a Scheduled Trading Day turned out to be an Unscheduled Holiday. It should be noted, however, that, in practice, even where this approach has been adopted, security holders may nonetheless express unhappiness when the unexpected change of the valuation date results in a worse economic outcome for them, so it is important to highlight the risks of this occurrence in advance to reduce the risk of disputes.

Trading Disruptions and Circuit Breakers

Any nationally or globally significant event or series of events (such as a pandemic, rising geo-political tensions or the imposition of tariffs) can create uncertainty in the financial markets, and, depending on the extent of its significance, result in large price swings and broad market disruption. The COVID-19 pandemic, for example, directly resulted in a heavy selloff of equities and equity-related securities in March 2020, which in turn then caused circuit breaker mechanisms across multiple exchanges to kick in. Specifically, the S&P 500 Index fell by more than 7% on various trading days in March 2020, which led to trading halts on all United States Stock Exchanges four times in March 2020 alone – an economically significant event, considering that the previous occurrence of the circuit breaker mechanism activating was in 1997³. More recently, the Tokyo Stock Exchange suspended trading for ten minutes amidst the Nikkei 225 Index falling by more than 8% shortly after opening on 7 April 2025, due to the United States President Donald Trump's announcement of the imposition of tariffs on its trading partners across the globe⁴.

When a circuit breaker mechanism is activated, the immediate and most common consequence is a trading halt or suspension. The extent of the suspension (i.e., whether the halt only applies to the share which experienced the rapid drop in price, or whether it applies to all shares listed on a particular exchange) and its duration will vary depending on the rules of the exchange, and may constitute what is commonly termed a "Trading Disruption" in both structured securities documentation and the 2002 ISDA EDD. A Trading Disruption is a type of Market Disruption Event, and is generally defined to include any suspension of, or limitation imposed on trading by the relevant exchange, whether by reason of price movements exceeding permissible limits or otherwise. To be considered as a Market Disruption Event, two other requirements usually have to be met: (i) the Calculation Agent must determine such Trading Disruption to be material and (ii) the relevant disruption must occur (or be subsisting) at some point during the one-hour period immediately prior to the time at which share valuation is scheduled to take place.

Theoretically, the concept of a Trading Disruption is simple, but its practical application may be complex and raise interesting questions for issuers to consider. This is because different exchanges have different kinds of circuit breaker mechanisms in place to deal with sudden price fluctuations, and it may be the case that they have other tools at their disposal apart from simply halting trading altogether. For example, in relation to futures and option contracts, the Tokyo Stock Exchange has circuit breaker measures in place which trigger automatic trading suspensions if certain price limits are breached⁵, but in relation to individual shares and ETFs which breach similar price limits, a different circuit breaker mechanism is used, whereby trading can still take place but not beyond a pre-defined upper or lower limit price⁶.

In the former case, it is clear that a Trading Disruption has occurred, and issuers can exercise the rights available under the relevant offering and issuance documentation to deal with such disruption. As this is a short-term disruption, the usual remedy involves postponement of the relevant valuation dates, with a built-in backstop, after which the Calculation Agent will, in good faith and a commercially reasonable manner, determine the value of the share to be used. In the latter case involving a price restriction/limitation mechanism imposed by the exchange, it is not as clear whether a Trading Disruption has occurred, and by extension, whether a Market Disruption Event has occurred on the assumption that the materiality and timing thresholds are met. One could argue that, since trading is still permissible in accordance with the rules of the exchange, it is neither "suspended" nor "limited" and hence a Trading Disruption would not have occurred – and whether any trades actually take place at the artificially limited price would be irrelevant. From a practical perspective, an issuer which needs to obtain the value of the affected share for the purposes of determining amounts payable under a securities issuance would still be able to do so. On the flipside, it could also be said that the exchange artificially preventing the price of a share from falling below a certain level should constitute a "limitation" on trading imposed by said exchange, given that the share price is no longer only subject to market demand and supply, and contracting parties are no longer free to agree on a particular price for transacting – hence the scenario above would be sufficient to constitute a Trading Disruption.

An interesting complication arises when the terms of the securities state that the share price is to be observed on a continuous, intra-day basis, rather than on a closing basis. In such a case, the timing requirement for a Market Disruption Event would be far less relevant, given that the share price is observed throughout the trading day. Furthermore, as issuers would be able to (where unaffected by disruption) observe the share price on a rolling basis throughout the day, they should carefully consider whether it is more economically beneficial to declare that a Market Disruption Event has occurred and trigger built-in adjustment mechanisms, or simply disregard the affected period for the purposes of share valuation (or, as is the case for some issuers, disregard the occurrence of such disruption when deciding whether or not a barrier event has occurred).

Sanctions

The financial markets have seen increasing uses of targeted economic sanctions in recent years. Economic sanctions are one of the tools in a government's arsenal which can be used to further or hinder certain political, economic or public policy objectives, and can be imposed on specific individuals, corporate entities or entire countries. They can vary in duration and can be imposed indefinitely, or stated to elapse automatically on a fixed, pre-determined date, or upon on the occurrence of certain events.

Structured securities which directly reference sanctioned entities (in the sense that the share issuer itself is subject to sanctions), or which reference entities located within sanctioned jurisdictions, may potentially be affected by such sanctions. If affected, there are numerous issues which need to be considered, including, but not limited to, (i) whether valuation of the relevant underlying shares can still be effected, (ii) whether payments can continue to be made in accordance with the current terms and conditions of existing securities, (iii) whether, on the assumption that it is necessary, physical delivery of the underlying shares can still be carried out, (iv) whether hedging arrangements are still effective, (v) whether the securities can be redeemed, exercised or terminated early in light of the sanctions and (vi) whether new securities can be issued which are linked to the sanctioned entities or entities located within the sanctioned jurisdictions.

How the issues above are eventually addressed depends on a multitude of considerations, including the scope and applicability of the sanctions which are imposed, the objectives which the issuer is attempting to achieve in light of the imposed sanctions, and whether the relevant offering and issuance documentation provide for mechanisms to deal with such sanctions. Structured securities programmes typically include provisions which may be used to deal with the disruption events that may consequentially arise from such sanctions, even if such provisions do not expressly refer to "sanctions" as a concept. These are often adapted from the 2002 ISDA EDD Additional Disruption Events, such as "Change in Law", "Hedging Disruption" or "Increased Cost of Hedging", and "Illegality" from the ISDA master agreements. Issuers should look to these as a starting point in assessing the scope of rights they are able to exercise and the scope of obligations they are required to meet upon the occurrence of the relevant disruption event.

Illegality or Change in Law provisions generally require the issuer to make a determination that the performance of its obligations will be, at least in part, unlawful or illegal, in the sense that it would contravene one or more existing laws, regulations, judgments or orders imposed by the relevant legislative, judicial or regulatory bodies. Should the issuer make a determination that the requirements in the relevant provision are met, it may be able to redeem the affected securities early (usually after notifying the security holders in advance) or make specific adjustments to the terms and conditions of the securities, depending on the exact language used in the relevant provisions. Issuers should carefully examine the language used in the instruments imposing the sanctions and determine whether they are applicable to each outstanding series of securities before exercising any of the above rights, lest they face legal and reputational risk from making an incorrect (or arguably incorrect) determination that they are entitled to exercise those rights. For example, if there is a specified divestment period before the sanctions take effect where buying and selling securities subject to sanctions are still permitted, it might be difficult for the issuer to determine that a Change in Law event has occurred during such a period, and any exercise of its rights under the Change in Law provisions on this basis may have to be delayed until the divestment period has concluded.

An alternative for issuers is to seek to apply Hedging Disruption or Increased Cost of Hedging provisions: depending on the specific language included, if such provisions apply, they would usually generally grant issuers the right to make adjustments to the terms and conditions of the securities or redeem the securities early with adequate notice.

ISDA has also provided guidance in relation to the imposition of economic sanctions and how the consequential issues should be dealt with between parties. The 2002 ISDA Master Agreement specifies illegality (in the sense that it would be unlawful under any applicable law for one or both of the parties to make or receive a payment or perform their obligations) as a "Termination Event", which, subject to certain conditions, simply means that party affected by the sanctions can terminate the relevant transactions early with adequate notice to the unaffected party. Specifically in the context of bilateral derivatives transactions, there are other considerations that may arise, including unwanted increases in economic exposure due to currency depreciation in the jurisdiction of the sanctioned entity and the risk that the counterparty deems non-payment (due to sanctions) to constitute an event of default. However, such issues do not arise in the context of structured products programmes where payments only flow from the issuer to the security holders, and not vice versa.

Finally, structured securities issuers ought to also consider the possible knock-on effects of the imposition of sanctions. Issues can arise in relation to dealing with the underlying shares, especially in situations where the terms and conditions of the issuance documents stipulate that physical settlement is applicable and needs to be effected. In such a case, the issuer might either be unable to obtain the necessary shares due to the relevant sanctions, or be subject to transfer restrictions in dealing with such shares. Structured products programmes generally include provisions (often termed "Physical Settlement Disruption Event", "Settlement Disruption Event" or something to the same effect) designed to deal with such scenarios, where the issuer may have the right to (i) delay physical settlement until it can obtain the necessary shares, or (ii) if still unable to obtain the necessary shares for a specified period, to partially or fully discharge its payment and redemption obligations by means of cash settlement instead.

Extraordinary Events

"Extraordinary Events" are medium to long-term disruptions which affect the issuer's ability to deal with the underlying share of certain structured securities. Such events include, amongst others, a consolidation or merger of a share issuer to another entity, or a transfer of all shares from the share issuer to another entity (a "Merger Event"), a takeover offer, tender offer or exchange offer resulting in a different entity holding greater than 10% but less than 100% of the outstanding voting shares of the share issuer (a "Tender Offer"), the nationalisation or expropriation of all or substantially all of the assets of a share issuer to a governmental authority (a "Nationalisation"), a transfer of all the shares of a share issuer to a trustee, liquidator, or other similar official due to the voluntary or involuntary liquidation, insolvency or dissolution or the share issuer (an "Insolvency"), and the shares of a particular share issuer ceasing to be listed, traded or publicly quoted on the relevant exchange, such cessation not being temporary and the shares not being re-listed on an alternative acceptable exchange (a "Delisting").

The above Extraordinary Events are found in the 2002 ISDA EDD, which are the usual starting point for issuers to incorporate provisions to deal with such events into their programme documentation. Furthermore, the scope of Extraordinary Events is dynamic, and can be freely amended to suit the particular needs of an issuer. The relevant definitions can be expanded to include not only ordinary shares, but also shares of exchange traded funds and depositary receipts, with the latter in particular adding significant complexity to the necessary provisions depending on how the issuer would prefer to address events which affect only the depositary receipt but do not similarly affect the underlying share (and vice-versa). The 2002 ISDA EDD (Versionable Edition) contains both "Full DR Lookthrough" and "Partial DR Lookthrough" provisions for the purpose of "looking through" the depositary receipt to the original underlying share, such that Extraordinary Events which affect one may also deemed to affect the other (the difference between the two being the extent of applicability), giving issuers the ability to exercise certain rights under the relevant offering and issuance documentation. In addition, issuers should take care to consider the provisions that apply when a deposit agreement is terminated; the default position under the 2002 ISDA EDD is "Cancellation and Payment", but an automatic and non-discretionary outcome may result in unwanted consequences.

In the context of Extraordinary Events, the key concern for issuers is to ensure that the triggering criteria for each event is clearly defined in the relevant offering documentation, such that they can confidently determine whether such an event has arisen and, in doing so, also decide whether they can exercise the rights granted by the occurrence of such events. Examples of possible rights which may arise are (subject to the programme documentation expressly granting such rights) (i) adjusting some (or all) of the terms of the securities in order to account for the effects of the Extraordinary Event, (ii) redeeming all of the securities affected by the Extraordinary Event, or (iii) substituting the affected share with a different share, where the new share has to be determined by reference to specific factors (e.g., belonging to a similar economic sector, or of a similar market capitalisation or international standing). The exercise of one or more of these rights is generally accompanied by a sufficiently detailed notice addressed to the relevant security holders. At a minimum, such a notice should expressly stipulate the issuer's determination that one or more Extraordinary Events have occurred, the basis for such a determination, and the rights that the issuer is planning to exercise with appropriate references to programme and issuance documentation.

Other authors: Viona Yiu, Assistant General Counsel and Director, Bank of America