Downgrade termination costs

Ratings-based (RB) additional termination event (ATE) clauses in International Swaps and Derivatives Association agreements can have a significant impact on the valuation of derivatives portfolios when rating events occur. Fabio Mercurio, Roberto Caccia and Massimo Cutuli explore this embedded optionality and its economic implications. A case study is provided to quantify the RB-ATE impact for a vanilla interest rate swap and a commodity option, and to analyse the sensitivity to ATE rating trigger levels

International Swaps and Derivatives Association agreements may contain additional termination event (ATE) clauses as part of section 5(b)(vi) of Isda (2002) (5(b)(v) in Isda, 1992), called ‘Events of default and termination events’. Typically, ratings-based (RB) ATE clauses give a counterparty the right to close out all derivatives contracts with a given financial institution (referred throughout as the bank) if the bank’s rating falls below a specified level above default, or, in some cases, is