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{{a|negotiation|}}The right to terminate a {{tag|master agreement}} as a result of the decline in [[net asset value]] of a [[hedge fund]] counterparty (other counterparty types generally won't have a “[[net asset value]]” ''to'' trigger).
{{a|pb|{{image|Trigger|jpg|A [[NAV trigger]] yesterday.}} }}{{NAV trigger capsule}}


Like most [[events of default]], [[NAV trigger]]s are a second-order derivative for the only really important type of default: a [[failure to pay]]. A significant decline in [[NAV]] makes a payment default ''more likely''. [[NAV]] declines in three main ways:
All rather tiresome, and quite unnecessary if you have the right, as most [[prime broker]]s do, to hike up [[initial margin]] at your discretion.<ref>I know, I know, there may be a [[margin lockup]]. That’s really the best place for the [[NAV trigger]], as you may come to agree if you read on.</ref>
*The value of [[Financial instrument|asset]]s (be they physical or derivative) declines
*The cost of financing those assets - the [[leverage]] - increases
*Investors withdraw money from the fund.
[[Prime broker]]s hold [[initial margin]] to protect against the first, control the second in any weather, and one would expect the third to result in overall proportionate de-risking anyway. <ref>Not always precisely, of course: thanks to Mr. Woodford for reminding us all that a manager handling redemptions will tend to nix [[liquid]] positions first. </ref> In any case, the benefit to a second order derivative close-out right is that it might allow you to get ahead of the game. If I know the default is coming (because NAV trigger, right?) why wait until a payment is due to see if I get hosed?


Because, in this age of high-frequency trading, multiple payments are due every day, and even if one isn't, in many cases you can force one by raising [[initial margin]]<ref>Assuming you have undercooked your IM calculations in the first place, that is. [[IM]] is designed to tide you over between payment periods after all. </ref>. All told, an ''actual'' failure to pay is deterministic. There is no argument. A NAV trigger breach - not so much.
===Types of [[NAV trigger]]===
 
Often there are three levels of trigger: '''Monthly'''; '''Quarterly''' and '''Annually'''. There is also an “absolute” NAV trigger, judged from the inception of the relationship to the current point in time, though the sense this one presumably makes to the [[Worshipful Company of Credit Officers]], has for many years eluded the [[JC]]. In any case you may find yourself in a [[tedious]] argument about whether your periodic NAV triggers should be “rolling” (that is, judged for the period from any day, even one on which there wasn’t an official NAV) or “point-to-point” (that is, judged between NAV calculation periods), which is more observable, being based on official NAV, but still arbitrary, as it gives you just a once-a-month opportunity to create a stink.<ref>Then again, you could make the point that cutting an official NAV once a month also gives one a somewhat arbitrary sense of the fund’s performance, as it does not track intra-month volatility.</ref>
Especially since an official [[NAV]] is only “cut” once for every “[[liquidity period]]” - monthly or quarterly in most cases - and it is hard to see how a [[credit officer]], however enthusiastic, could determine what the [[net asset value]] was at any other time. On the other hand, [[credit officer]]s don’t usually monitor NAV triggers anyway, so what do they care?
 
All rather tiresome, and quite unnecessary if you have the right, as most [[prime broker]]s do, to jack up [[initial margin]] at your discretion<ref>I know, I know, there may be a [[margin lockup]]. That’s really the best place for the NAV trigger, as you may agree if you read on.</ref>.
 
===Types of NAV trigger===
Often there are three levels of trigger: '''Monthly'''; '''Quarterly''' and '''Annually'''. You may find yourself embraced in a tedious argument about whether these should be “rolling” (that is, judged for the period from any day) or “point-to-point” (that is, judged from a defined day to the end of the period following that day).


===The exhilarating process of waiving a NAV trigger breach===
===The exhilarating process of waiving a NAV trigger breach===
Even though [[NAV trigger|NAV triggers]] aren’t usually monitored, they can lead to the tedious cottage industry of [[waiver|waiving]] their breach. This is because while a [[prime broker]]’s [[credit department]] won’t have the inclination (or bandwidth) to monitor the thousands of NAV triggers it has buried in its contract portfolio, each [[hedge fund]] who has granted one will and, if<ref>''When''.</ref> it suffers a significant drawdown, won’t like an unexploded {{isdaprov|Additional Termination Event}} sitting on its conscience. So, it will ask for a [[waiver]]. If it has clever lawyers, it will explain that it has heightened [[cross default]] risk as a result. It may insist on one, even though you would think it ought to be in no position to be insisting anything.  
Even though [[NAV trigger|NAV triggers]] aren’t usually monitored, they can lead to the tedious cottage industry of [[waiver|waiving]] their breach. This is because while a [[prime broker]]’s [[credit department]] won’t have the inclination (or bandwidth) to monitor the thousands of NAV triggers it has buried in its contract portfolio, each [[hedge fund]] who has granted one will and, if<ref>''When''.</ref> it suffers a significant drawdown, won’t like an unexploded {{isdaprov|Additional Termination Event}} sitting on its conscience. So, it will ask for a [[waiver]]. If it has clever lawyers, it will explain that it has heightened [[cross default]] risk as a result. It may insist on one, even though you would think it ought to be in no position to be insisting anything.  


No no-one likes to give a free waiver. Why would you?
{{maxim|No no-one likes to give a free waiver}}. Why would you?


Yet, thanks to the [[no oral modification]] clause in Section {{isdaprov|9(b)}} — which extends to waivers — you ''must'' waive a [[NAV trigger]] in writing<ref>This has been recently confirmed in {{casenote|Rock Advertising Limited|MWB Business Exchange Centres Limited}}.</ref>. This then leads to an argument between [[legal]] and [[credit ]] as to ’whose job it is to send out this waiver. Honestly, this is such fun.
Yet, thanks to the [[no oral modification]] clause in Section {{isdaprov|9(b)}} — which extends to waivers — you ''must'' waive a [[NAV trigger]] in writing.<ref>This has been recently confirmed in {{casenote|Rock Advertising Limited|MWB Business Exchange Centres Limited}}.</ref> This then leads to an argument between [[legal]] and [[credit ]] as to ''whose job it is to send out this waiver''. Honestly, this is such fun.


'''[[Legal]]''': “You imposed the stupid [[NAV trigger]], so you can damn well send out waivers for it.”
'''[[Legal]]''': “You imposed the stupid [[NAV trigger]], so you can damn well send out waivers for it.” <br>
'''[[Credit]]''': “Help! Help! It’s a legal agreement! I am not qualified to do this! I cannot opine!”<br>


'''[[Credit]]''': “Help! Help! It’s a legal agreement! I am not qualified to do this! I cannot opine!”
You’ll never guess where the [[JC]]’s sympathies lie. By the way, [[Waiver by estoppel|waiving]] a [[breach of contract]] under [[English law]], without [[consideration]], is unlikely to permanently change your contractual terms for the worse<ref>See [[waiver by estoppel]] and [[no oral modification]] for a more developed discussion.</ref> — a motivating fear of all [[legal eagles]] and [[credit officers]] — but may well do, if you are not careful, under the [[New York law|laws of the State of New York]]<ref>See [[course of dealing]].</ref> as it may create a [[course of dealing]].


You’ll never guess where the [[JC]]’s sympathies lie.
===So, put the NAV trigger in a [[margin lockup]]===
Presuming you have reserved the right, as any sensible [[prime broker]] will, to increase [[initial margin]] at any time, there is a way out of this. It ought to work perfectly well, though [[credit]] won’t like it: ''put [[NAV trigger]]s in the [[margin lockup]] and not the [[master agreement]].  


===So, put the NAV trigger in a margin lockup===
(Why won’t [[credit ]] like it? ''Because it means they won’t have anything to do''.)
Presuming you have reserved the right, as any sensible [[prime broker]] will, to increase [[initial margin]] at any time, there is a way out of this. It ought to work perfectly well, though [[credit]] won’t like it: ''put [[NAV trigger]]s in the [[margin lockup]] and not the master agreement.  


This means the [[NAV trigger]] is no longer, of itself, a {{isdaprov|Termination Event}} under the {{isdama}}. All it entitles you to do is raise [[initial margin]]. Calling for more IM will achieve one of two things:
This means the [[NAV trigger]] is no longer, of itself, a {{isdaprov|Termination Event}} under the {{isdama}}. All it entitles you to do is raise [[initial margin]]. Calling for more IM will achieve one of two things:
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Sigh.
Sigh.


{{Seealso}}
{{sa}}
*[[NAV]]  
*[[NAV]]  
*[[NAV per share]]  
*[[NAV per share]]  

Latest revision as of 15:53, 15 June 2023

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A NAV trigger yesterday.
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A NAV trigger is the right to terminate a master agreement as a result of the decline in net asset value of a hedge fund counterparty (other counterparty types generally won’t have a “net asset value” to trigger).

Like most events of default, NAV triggers are a second-order derivative for the only really important type of default: a failure to pay. A significant decline in NAV makes a payment default more likely. NAV declines in three main ways:

  • The value of assets (be they physical or derivative) declines;
  • The cost of financing those assets - the leverage - increases;
  • Investors withdraw money from the fund.

Prime brokers hold initial margin to protect against the first, control the second in any weather, and one would expect the third to result in overall proportionate de-risking anyway. [1] In any case, the benefit to a second order derivative close-out right is that it might allow you to get ahead of the game. If I know the default is coming (because NAV trigger, right?) why wait until a payment is due to see if I get hosed?

Because, in this age of high-frequency trading, multiple payments are due every day, and even if one isn’t, in many cases you can force one by raising initial margin.[2] All told, an actual failure to pay is deterministic. There is no argument. A NAV trigger breach — not so much.

Especially since an official NAV is only “cut” once for every “liquidity period” — monthly or quarterly in most cases — and it is hard to see how a credit officer, however enthusiastic, could determine what the net asset value of the fund was at any other time, not having knowledge of those positions held with other counterparties. On the other hand, credit officers don’t usually monitor NAV triggers anyway, so what do they care?

All rather tiresome, and quite unnecessary if you have the right, as most prime brokers do, to hike up initial margin at your discretion.[3]

Types of NAV trigger

Often there are three levels of trigger: Monthly; Quarterly and Annually. There is also an “absolute” NAV trigger, judged from the inception of the relationship to the current point in time, though the sense this one presumably makes to the Worshipful Company of Credit Officers, has for many years eluded the JC. In any case you may find yourself in a tedious argument about whether your periodic NAV triggers should be “rolling” (that is, judged for the period from any day, even one on which there wasn’t an official NAV) or “point-to-point” (that is, judged between NAV calculation periods), which is more observable, being based on official NAV, but still arbitrary, as it gives you just a once-a-month opportunity to create a stink.[4]

The exhilarating process of waiving a NAV trigger breach

Even though NAV triggers aren’t usually monitored, they can lead to the tedious cottage industry of waiving their breach. This is because while a prime broker’s credit department won’t have the inclination (or bandwidth) to monitor the thousands of NAV triggers it has buried in its contract portfolio, each hedge fund who has granted one will and, if[5] it suffers a significant drawdown, won’t like an unexploded Additional Termination Event sitting on its conscience. So, it will ask for a waiver. If it has clever lawyers, it will explain that it has heightened cross default risk as a result. It may insist on one, even though you would think it ought to be in no position to be insisting anything.

No no-one likes to give a free waiver. Why would you?

Yet, thanks to the no oral modification clause in Section 9(b) — which extends to waivers — you must waive a NAV trigger in writing.[6] This then leads to an argument between legal and credit as to whose job it is to send out this waiver. Honestly, this is such fun.

Legal: “You imposed the stupid NAV trigger, so you can damn well send out waivers for it.”
Credit: “Help! Help! It’s a legal agreement! I am not qualified to do this! I cannot opine!”

You’ll never guess where the JC’s sympathies lie. By the way, waiving a breach of contract under English law, without consideration, is unlikely to permanently change your contractual terms for the worse[7] — a motivating fear of all legal eagles and credit officers — but may well do, if you are not careful, under the laws of the State of New York[8] as it may create a course of dealing.

So, put the NAV trigger in a margin lockup

Presuming you have reserved the right, as any sensible prime broker will, to increase initial margin at any time, there is a way out of this. It ought to work perfectly well, though credit won’t like it: put NAV triggers in the margin lockup and not the master agreement.

(Why won’t credit like it? Because it means they won’t have anything to do.)

This means the NAV trigger is no longer, of itself, a Termination Event under the ISDA Master Agreement. All it entitles you to do is raise initial margin. Calling for more IM will achieve one of two things:

Thus, it doesn’t trouble fastidious types who fuss about cross default or DUST, and the consequences of the trigger are in any case less apocalyptic for the fund, and less demanding of a waiver.

“But I don’t want to have a margin lockup just so I can have my NAV trigger”, your credit will wail.

Sigh.

See also

References

  1. ↑ Not always precisely, of course: thanks to Mr. Woodford for reminding us all that a manager handling redemptions will tend to nix liquid positions first.
  2. ↑ Assuming you have under-cooked your IM calculations in the first place, that is. IM is designed to tide you over between payment periods after all.
  3. ↑ I know, I know, there may be a margin lockup. That’s really the best place for the NAV trigger, as you may come to agree if you read on.
  4. ↑ Then again, you could make the point that cutting an official NAV once a month also gives one a somewhat arbitrary sense of the fund’s performance, as it does not track intra-month volatility.
  5. ↑ When.
  6. ↑ This has been recently confirmed in Rock Advertising Limited v MWB Business Exchange Centres Limited.
  7. ↑ See waiver by estoppel and no oral modification for a more developed discussion.
  8. ↑ See course of dealing.
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