A provision in a derivative contract that stipulates immediate contract termination with a cash settlement if the credit rating of one counterparty falls below a specific level. A downgrade provision may also state that some substantive change will affect the contract if a reference credit’s rating falls below a prespecified level. An affected counterparty will have the option to close out the contract at its market value. A downgrade triggers is mainly designed to protect a derivative buyer from credit risk. The buyer must insure that a downgrade trigger is activated at some point before the counterparty is plunging into financial distress.
January 17, 2024
