Indemnification Method
What Is the Indemnification Method?
The indemnification method computes the termination payments when a swap is ended early and the holder has accepted an offer of prepayment.
The indemnification method can measure up to two other acceptable termination repayment strategies, which are the formula and agreement value methods.
Grasping the Indemnification Method
The term indemnity means protection against liability. The indemnification method requires the to blame counterparty to remunerate the responsible counterparty for all losses and damages brought about by an early termination.
This method was common when swaps were first developed yet was considered inefficient in light of the fact that it didn't really measure, or portray how to evaluate, those losses and damages from a rashly terminated swap. Today, the "agreement value method," which depends on the conditions and interest rates accessible for a replacement swap, is the most widely involved method for computing termination payments. Another more uncommon alternative is the formula method.
A swap is an agreement made between two counterparties to exchange cash flows (for instance, fixed-for-floating) alongside underlying currencies or different securities, like commodities, terminating at a pre-determined date from now on. A swap contract might be terminated early if either counterparty encounters a credit event or default, for example, bankruptcy or inability to pay, or a termination event, like a lawlessness, tax event, tax event upon a merger, or other contingency. The scope of what considers an early termination event and how it will be figured out will be made explicit in the swap's termination clause.
History of the Indemnification Method
Initially, the indemnification method was utilized to restore the counterparty who encountered a loss as the consequence of the other counterparty terminating the swap agreement early. Under this method, the to blame (terminating) party must restore (repay) the whole loss experienced by the other party due to the early termination.
In any case, since it isn't clear precisely how much money that counterparty will wind up losing, both explicitly and in terms of opportunity costs, the formula method was acquainted with lay out an unmistakable methodology for showing up at the indemnity amount, as opposed to it being an impromptu organization.
Thus, the formula method was itself supplanted by the more commonly utilized agreement value method, which replaces the non-normalized formula for computing a loss with a simple measurement, which is the cost of going into a replacement swap. The replacement swap involves the new swap agreement that the harmed counterparty would need to go into to restore the original swap position.
Be that as it may, since swap prices change after some time and as interest rates and different factors vary, the replacement contract might have various terms and market prices than the original swap. That difference in cost, to enter the new agreement with another counterparty, is the agreement value and ought to reimburse the harmed party.
Features
- The indemnification method is one method for working out the amount owed by one counterparty to one more on account of the early termination of a swap.
- The agreement value method, which depends on the conditions and interest rates accessible for a replacement swap, is viewed as more efficient than the indemnification method for working out termination payments.
- Initially, the indemnity method was utilized to restore the counterparty who encountered a loss as the consequence of the other counterparty terminating the swap agreement early.
- The indemnification method requires the to blame counterparty to remunerate the responsible counterparty for all losses and damages brought about by the early termination.
