Template:M gen Equity Derivatives 12.8: Difference between revisions

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===Negotiation tips===
===Negotiation tips===
[[Cancellation Amount - Equity Derivatives Provision|If]] you have the privilege or representing a [[dealer]], prepare to experience one of the great old chestnuts of the equity derivatives world. Dispute rights.  
[[Cancellation Amount - Equity Derivatives Provision|If]] you have the privilege or representing a [[dealer]], prepare to experience one of the great old chestnuts of the equity derivatives world: Dispute rights.  


{{dispute rights capsule}}
{{Calculation agent dispute}}
 
[[Buyside counsel]] will delight in requesting elaborate dispute mechanisms, which they will have cribbed from their days as deal counsel on synthetic [[CDO squared]] deals, when they earned their fortunes penning cascading dispute provisions that would run for five unpunctuated pages. A couple of things to note:
 
Firstly, in those [[CDO squared]] the counterparty was, needless to say, the dealer’s own [[SPV]], and it would neither ''seek'' a dispute provision, much less ''invoke'' one if it had it. That it ''did'' have one was an elaborate charade put on by the [[dealer]] for the sake of credulous ratings agencies, who laboured under the motivated irrationality of believing a [[calculation agent dispute right]] did a damn of good, and might meant that these piles of toxic waste could earn a AAA rating. I mean, just fancy.
 
Secondly, the disputability of derivative valuations, generally, falls into two camps: one one hand, those of liquid, publicly observable asset classes — such as those in the [[spot FX]] and listed equities markets — whose valuations derive from objectively-reported, independent market transactions and there isn’t really a great deal of scope for debate and, on the other, those that asset classes that comprise exotic, bespoke, “bull-''market''”<ref>This is one of those occasions where “bull-market” and “bull shit” are exact synonyms.</ref> transactions, which spring from the fevered imagination of credit [[structurer]]s and depend on fantastical internal models of convexity curves, volatility smiles and other such exotic confections. These, no-one but the mad professor who confected them could calculate, much less want to, and for absolute certain the person ''employing'' said mad professor — the [[dealer]] — would not dream of allowing anyone else to second guess those calculation because upon them is predicated the very, colossal, PNL on which the trade is predicated.
 
Anyway, I digress. Suffice to say [[equity derivatives]] belong to the ''former'' category. They are an access product: the dealer provides exposure without taking a naked proprietary position one way or another. It hedges [[delta-one]], so and is remunerated by means of (i) a [[commission]] for putting the trade on and taking it off, and (ii) managing the spread between the financing cost it charges and the net funding cost of its hedging activity. (For a full account, see ''[[prime brokerage charging]]''). Equity derivatives [[dealer]]s do not take a proprietary position.
 
They broadly determine the prices of your swap exactly as they would for cash equity brokerage: by buying or selling shares, only for its hedge, not for your account. Just as you wouldn't get a dispute right on cash brokerage trade — good luck saying, “yeah, I have another broker telling me it could have got a better price” to a stock broker —nor, really should you on a synthetic. The whole theory of the game is that it is a liquid market and the dealer has better access to that market than you do. If you can get better prices elsewhere, ''go'' elsewhere.

Latest revision as of 09:24, 4 May 2021

Negotiation tips

If you have the privilege or representing a dealer, prepare to experience one of the great old chestnuts of the equity derivatives world: Dispute rights.

A dispute right for Calculation Agent and Determining Party determinations?

Recognising that “should you?”, and “will you have to?”, are different questions — buyside counsel may insist, using their regular platter of exotic preparations of canard that buyside lawyers always serve up, and you may ultimately decided not to die in a ditch about it, however much it pains you — recognising all that; here — if you are doing synthetic prime brokerage business — is how it rolls.

Client’s lawyer: we must have a dispute right, so help me.

  • The Dealer will be the Calculation Agent. (True.)
  • The Dealer will be the Hedging Party. (True.)
  • The Dealer will be the Determining Party. (True.)
  • Dealers are bad, venal people. They have blackened hearts and will stop at nothing to rip their clients’ faces off. We need some check on their unfettered and sure-to-be outrageously exercised discretion. (A matter of debate and, to be sure, recent history has not looked kindly on the goings on in some dealers, but if that’s your starting point a far better question is “why are you doing business with such a rascal in the first place”? And generally, hedge funds haven’t had a spotless track record either, have they? For every Lehman, there’s been an LTCM, Amaranth, Archegos, SAC, Galleon and, er, Madoff.)

The Dealer’s lawyer: Look, dudes, you seem to be missing the point.

  • Firstly, This is synthetic prime brokerage. It isn’t an arm’s length trading arrangement. It is business facilitation for you. When we hedge, we are delta neutral. That means if our hedge pays us 50, we pay you 50. So firstly, we can’t rip your face off, even though it is one only a mother could love.
  • Secondly, we are owe you best execution[1]
  • Thirdly, because we delta hedge, we come up with our “determinations” by actually selling the right number of shares. It isn’t like we confect some hypothetical valuation based on a model some geek in correlation trading built in excel. We don’t go ask some stooge dealers for a soft estimate, and promise them champagne in the mail. We actually sell the stock. Our own money out the door. We can’t get it back. What you are asking is to second guess our actual transaction by you asking some stooge dealer for a soft estimate. This is like putting a bet on Crystal Palace to beat Scunthorpe and when Palace loses, telling the bookmaker: “but my buddy is a football expert, and he says Palace were dead unlucky, hit the crossbar a couple of times, and that Scunthorpe goal should have been disallowed, so really it should have been a 4:0 win to Palace. So you have to pay me anyway.”
  • Fourthly, there are a ton of controls on us already, contractual, regulatory and economic:
    • Contractual: Section 12.8 of the Equity Derivatives (especially Sections 12.8(b) and 12.8(g)) is shot through with requirements to act in a commercially reasonable manner, using commercially reasonable procedures, going out to leading dealers and so on. Likewise, a whenever a Calculation Agent is acts or exercises judgment in any way, it must do so in good faith and in a commercially reasonable manner (See Section 1.40). What the dispute provision is aimed to do, your adversary will say, is provide a stick to enforce that obligation. but at some point this becomes an infinite regression: what if the dispute is not registered in good faith? Where is the stick to enforce that?
    • Regulatory: There's the best execution obligation. The COBS rules require us to treat our clients fairly.
    • Economic: You are the client. You can pull your business. You can decide to never give us another trade. Seeing as we are delta-one hedged, we have no incentive at all to lowball, and every incentive to give you the best price we can manage.
  1. ↑ Admittedly this only holds if the Dealer does owe best execution, but if it is MiFID-regulated and you are a professional client, it will.
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