Template:M summ 2018 CSD 13(h): Difference between revisions

Latest revision as of 15:42, 18 March 2022

What an omnishambles. ISDA’s crack drafting squad™ may usually be tiresome, leaden in its literary style, and pernickety to the point of distraction, but one thing you can say for it is that it does, usually, do things properly. It is thorough. It leaves no stone unturned, even when you wish it rather had.

With this provision it looks like the ’squad got to the point of maximum disarray, with all rocks upturned and slaters, bugs and cockroaches scuttling everywhere, and it just had a tantrum and stormed off. These provisions don’t even make sense. They are not even grammatical.

The basic problem, part I

The problem to be solved is this: initial margin is designed to cover mark-to-market exposure between (usually daily) variation margin calls. It is usually calculated to cover the likely possible change in portfolio value over that “liquidity period”, given the potential drop in collateral value over the same period. That is, one day.

However, when a counterparty goes titten hoch, the process of closing it out and determining who is owed what is a long process. For a big complex financial institution, can be months or years. One day’s market move starts to look a little bit meagre. Seeing as the initial margin is, by regulation, in the shape of non-cash assets, it too is subject to the vagaries of the market and can move up or down. So it might not quite cover what you thought it was going to cover.

to a great extent, that is just the non-linear unpredictable risk of the market. The answer is to take more collateral, of better quality, but that has its limits. So the alternative is to at least allow people in to convert the collateral into cash, to stop half of the portfolio moving around.

But fundamentally, this is just one of those risks it would be lovely to banish, but you can’t. Sorry, regulators!

The basic problem part II

Now remember: unlike variation margin, where only the in-the-money counterparty holds it, there are necessarily two buckets of Regulatory IM at all times: the stuff you posted as security for mark-to-market moves against you, and the stuff the other guy posted as mark-to-market movements against her.

Now: if a catastrophic event affects one party that precipitates a close-out, you stop exchanging variation margin. There’s no point: one side can’t pay it, Q.E.D.; the other side would be mad to pay it (and thanks to Section 2(a)(iii), doesn’t have to in any case).

At the last point that the parties exchanged VM, the net mark-to-market of the whole portfolio was (more or less) nil. After that point, until all Transactions are terminated, the MTM value of the portfolio will swing around. It could go either way. It does not follow that the Unaffected Party will be owed any money. By the time it has determined the Early Termination Amount, it may owe the defaulting party money. Until then it doesn’t need its own initial margin back, it should not get its initial margin back, and nor should it get to take the Affected Party’s initial margin.

This is just my opinion.

What was ISDA’s crack drafting squad™ trying to achieve?

So this brings us to the abomination we find on the page before us. God only knows what ISDA’s crack drafting squad™ thought they were trying to achieve. Whatever remote objective they had as a goal, and whatever contingencies were dogging the ’squad’s fevered subconscious as they trudged, in formation, through the moist, dengue-infested swamps of of this drafting exercise — and there is some talk that there may have been skirmishes with pockets of rogue buy-side advisors to distract them as they went waded through hip-high sludge — what is left to posterity is a confused, gibbering disaster.

What did they need to achieve? Straightforward.

All this provision does is describe when a Secured Party can actually take the initial margin the Custodian (IM) is holding for it — the return of its own initial margin, and the stuff the other guy has posted, assuming the other guy is the one who, at the end of the day, owes the money.

You should not be surprised to hear this should be, more or less, when the Chargor has actually defaulted and been closed out, the Early Termination Amount calculated, been found to be owed by the Chargor, and the Chargor having failed to pay it — and, really, the control of secured collateral held subject to a “Control Agreement” would ordinarily be most suitably dealt by that Control Agreement. The clue, surely, is in the name? Well, the 2018 English law IM CSD does its own job or determining when this would be — it does a horrible job of it, truth be told, but it is a job — so (anecdotally) the market-standard Control Agreements all tend to defer to the Secured Party Rights Event as determined under the 2018 English law IM CSD. So here we are.

What did they achieve?

An unholy mess. The starting point — crafted by sell-side-influenced squad™, endeavours to match the regulatory margin regime as closely as possible to the broker-imposed contractual initial margin regime. But — and say what you like about the wisdom of regulation-enforced bilateral initial margin — bilateral, regulation enforced initial margin is a different prospect altogether. We suppose the squad may have been in some denial about this, and the worldwide community of regulators may have been in some denial that the sell-side would be in denial about it, too. But for the record, here are the differences:

It is bilateral: Contractual margin tends not to be: the brokers require their customers to provide it. The customers don’t ask for it from brokers.
It is title transfer:^[1] Therefore, whoever holds initial margin generally has it, to use as it sees fit, at all times. Where initial margin is posted away to a third party custodian with expressly no right of reuse, things are different.
It is held in safekeeping by a third party: Again, if you don’t hold the margin, you can’t reuse it, are not meant to be able raise funds against it, it does not secure present indebtedness,^[2] it is there purely as a credit default mitigant.

That starting point, therefore — “an Early Termination Date in respect of all Transactions has occurred or been designated as the result of an Event of Default or Access Condition with respect to the Chargor” — is one buy-side counsel are unlikely to like, as it allow a Secured Party to spring Posted Credit Support (IM) out of the Custodian’s possession at an arbitrary date at which time you do not know whether you are even owed anything. You don’t even know whether you are owed anything on the Early Termination Date for that matter (and since it is bilateral, nor, really should sell-side legal eagles like it, either).

Or you can elect to let your Control Agreement govern.

What would the JC suggest?

If you can resist the urge to fire them at ISDA’s headquarters, you can damn the torpedoes and take the JC’s recommendation, as discussed below.

↑ Or there is a wide-ranging right of reuse, which makes it effectively title transfer.
↑ Okay, this is true of all initial margin. But where you don’t even hold it, there should not be the temptation, you know?

[1] Or there is a wide-ranging right of reuse, which makes it effectively title transfer.

[2] Okay, this is true of all initial margin. But where you don’t even hold it, there should not be the temptation, you know?

[1]

[2]

@@ Line 2: / Line 2: @@
 With this provision it looks like the ’squad got to the point of maximum disarray, with all rocks upturned and slaters, bugs and cockroaches scuttling everywhere, and it just had a tantrum and stormed off. These provisions don’t even make ''sense''. They are not even ''grammatical''.
-===What were they ''trying'' to achieve? go figure.===
+===The basic problem, part I===
-God only knows what they thought they were ''trying'' to achieve. Whatever remote objective they had as a goal, and whatever contingencies were dogging [[the ’squad]]’s fevered subconscious as they trudged, in formation, through the moist, dengue-infested swamps of of this drafting exercise — and there is some talk that there may have been skirmishes with pockets of rogue [[Buyside counsel|buy-side advisors]] to distract them as they went waded through the hip-high sludge —  what is left to posterity is a confused, gibbering disaster.
+The problem to be solved is this: [[initial margin]] is designed to cover [[mark-to-market]] [[exposure]] between (usually daily) [[variation margin]] calls. It is usually calculated to cover the likely possible change in portfolio value over that “liquidity period”, given the potential drop in collateral value over the same period. That is, ''one day''.
-===What did they ''need'' to achieve? Straightforward===
+However, when a counterparty goes ''[[titten hoch]]'', the process of closing it out and determining who is owed what is a long process. For a big complex financial institution, can be months or years. One day’s market move starts to look a little bit meagre. Seeing as the [[initial margin]] is, by regulation, in the shape of non-cash assets, it too is subject to the vagaries of the market and can move up or down. So it might not quite cover what you thought it was going to cover.
-All this provision does is describe ''when'' a {{imcsdprov|Secured Party}} can actually take the [[initial margin]] the {{imcsdprov|Custodian (IM)}} is holding for it.
-You should not be surprised to hear this should be, more or less, ''when the {{imcsdprov|Chargor}} has actually defaulted and been closed out'' — and, really, the control of secured collateral held under {{imcsdprov|Control Agreement}} would ordinarily be most suitably dealt ''by that {{imcsdprov|Control Agreement}}''. The clue, surely, is in the name?
+to a great extent, that is just the non-linear unpredictable risk of the market. The answer is to take more collateral, of better quality, but that has its limits. So the alternative is to at least allow people in to convert the collateral into cash, to stop half of the portfolio moving around.
-Until the {{isdama}} has been fully closed out and the {{isdaprov|Early Termination Amount}} — that is, the total amount due following termination and valuation of all {{isdaprov|Transaction}}s following the default —  determined, you don’t definitively know what you are owed — even ''if'' you are owed anything: only one party to an {{isdama}} can be owed something, remember — so until then, what business have you got appropriating the {{imcsdprov|Initial Margin}}? Nor do you have any credit risk over it: it is held at a third party and [[secured]] in your favour. ''Cool your jets''.
+But fundamentally, this is just one of those risks it would be lovely to banish, but you can’t. Sorry, regulators!
-But that event — by our read, a “Failure to Pay Early Termination Amount” — isn’t even the default value for a {{imcsdprov|Secured Party Rights Event}}: rather, it is one of a tangled menu of alternatives.
+===The basic problem part II===
-===The alternatives===
+Now remember: unlike [[variation margin]], where only the [[in-the-money]] counterparty holds it, there are necessarily ''two'' buckets of [[Regulatory IM]] at all times: the stuff ''you'' posted as security for [[mark-to-market]] moves against ''you'', and the stuff ''the other guy'' posted as [[mark-to-market]] movements against ''her''.
-====As-standard: a “designated Early Termination Date”====
-The as-standard Secured Party Rights Event in the {{imcsd}} is the designation of an {{isdaprov|Early Termination Date}} in respect of all {{isdaprov|Transaction}}s following an {{isdaprov|Event of Default}} but — unless designated as an “{{imcsdprov|Access Condition}}” — not a ''normal'' {{isdaprov|Termination Event}} or an [[Additional Termination Event - ISDA Provision|''Additional'' Termination Event]].  For what it is worth, “Access Conditions” are a list of Termination Events and Additional Termination Events set out in Paragraph 13(e)(ii) for each of which one can opt — severally for each party — in your elections. What on earth {{iscd}} managed to achieve with such pointless, fine-grained optionality (other than a sumptuous lifestyle for the hoardes of legal eagles who will feast on client negotiations as a result) it is hard to say.
-In any case, just as a piece of design this is cruddy: ''any'' event leading to the early termination of all outstanding {{isdaprov|Transaction}}s, should count as a {{imcsdprov|Secured Party Rights Event}}, since at that point you are off risk, right? And before you complain that this is too wide, since there may still be amounts undetermined, or not as yet due under those {{imcsdprov|Transaction}}s, well, yes: that is exactly why the {{isdaprov|Early Termination Date}} is the wrong trigger point in the first place.
+Now: if a catastrophic event affects one party that precipitates a close-out, ''you stop exchanging [[variation margin]]''. There’s no point: one side ''can’t'' pay it, [[QED|Q.E.D.]]; the other side would be ''mad'' to pay it (and thanks to Section {{isdaprov|2(a)(iii)}}, doesn’t have to in any case).
-''Why do you need to appropriate {{imcsdprov|Initial Margin}} before you know if you are actually owed anything?
+At the last point that the parties exchanged [[VM]], the net [[mark-to-market]] of the whole portfolio was (more or less) nil. After that point, until all {{isdaprov|Transaction}}s are terminated, the MTM value of the portfolio will swing around. It could go ''either'' way. ''It does not follow that the {{isdaprov|Unaffected Party}} will be owed any money''. By the time it has determined the {{isdaprov|Early Termination Amount}}, it may ''owe'' the defaulting party money. Until then it doesn’t need its own [[initial margin]] back, it ''should not'' get its initial margin back, and nor should it get to take the {{isdaprov|Affected Party}}’s [[initial margin]].
-====Failing that: “{{imcsdprov|Failure to Pay Early Termination Amount}}”====
-(Quick drafting point: this means that a party fails to pay its {{isdaprov|Early Termination Amount}}, not that there is an {{isdaprov|Early Termination Amount}} determined following a {{isdaprov|Failure to Pay of Deliver}} {{isdaprov|Event of Default}}). That being the case, this is — well, if it covered all {{isdaprov|Termination Events}}, would be — the obvious best choice: it means, beyond any doubt the counterparty really has failed, it really did owe something, and it really did fail to pay it.
-''Now'' you have all the justification you need to wade in and repossess your counterparty’s initial margin. Only, oddly, it doesn’t capture finally determined {{isdaprov|Early Termination Amount}}s that were caused by ''non''-{{isdaprov|Events of Default}} (the so-called “{{imcsdprov|Access Condition}}s”). Why, since at this point you have failed to pay the amount, and? Search me, readers.
+This is just my opinion.
-====Failing (or in addition to that: “{{imcsdprov|Access Condition}}s”====
+===What was {{icds}} ''trying'' to achieve?===
+So this brings us to the abomination we find on the page before us. God only ''knows'' what {{icds}} ''thought'' they were ''trying'' to achieve. Whatever remote objective they had as a goal, and whatever contingencies were dogging [[the ’squad]]’s fevered subconscious as they trudged, in formation, through the moist, dengue-infested swamps of of this drafting exercise — and there is some talk that there may have been skirmishes with pockets of rogue [[Buyside counsel|buy-side advisors]] to distract them as they went waded through hip-high sludge —  what is left to posterity is a confused, gibbering disaster.
+===What did they ''need'' to achieve? Straightforward.===
+All this provision does is describe ''when'' a {{imcsdprov|Secured Party}} can actually take the [[initial margin]] the {{imcsdprov|Custodian (IM)}} is holding for it — the return of its own [[initial margin]], and the stuff the other guy has posted, assuming the other guy is the one who, at the end of the day, owes the money.
-===Cutting through the nonsense===
+You should not be surprised to hear this should be, more or less, ''when the {{imcsdprov|Chargor}} has actually defaulted and been closed out, the Early Termination Amount calculated, been found to be owed by the {{imcsdprov|Chargor}}, and the {{imcsdprov|Chargor}} having failed to pay it '' — and, really, the control of secured collateral held subject to a “{{imcsdprov|Control Agreement}}” would ordinarily be most suitably dealt ''by that {{imcsdprov|Control Agreement}}''. The clue, surely, is in the name? Well, the {{imcsd}} does its own job or determining when this would be — it does a ''horrible'' job of it, truth be told, but it is a job — so (anecdotally) the market-standard {{imcsdprov|Control Agreement}}s all tend to defer to the {{imcsdprov|Secured Party Rights Event}} as determined under the {{imcsd}}. So here we are.
-For those who don’t trust {{imcsdprov|Control Agreement}}s to do what they say on the tin, consider this kind of wording:
-{{quote|“'''{{imcsdprov|Secured Party Rights Event}}'''” means that, following the occurrence or designation of an {{isdaprov|Early Termination Date}} with respect to all outstanding {{isdaprov|Transaction}}s, an {{isdaprov|Early Termination Amount}} payable by the {{imcsdprov|Chargor}} has been determined and notified to the {{imcsdprov|Chargor}} under Section {{isdaprov|6(d)}}, and the {{imcsdprov|Chargor}} has not paid it in full when due under Section {{isdaprov|6(d)(ii)}}.}}
+===What ''did'' they achieve?===
+An unholy mess.  The starting point —  crafted by [[sell-side]]-influenced squad{{tm}}, endeavours to match the ''regulatory'' margin regime as closely as possible to the broker-imposed ''contractual'' initial margin regime.  But — and say what you like about the wisdom of regulation-enforced bilateral initial margin — bilateral, regulation enforced initial margin is a different prospect altogether. We suppose the squad may have been in some denial about this, and the worldwide community of regulators may have been in some denial that the sell-side would be in denial about it, too.  But for the record, here are the differences:
+# '''It is bilateral''': Contractual margin tends not to be: the brokers require their customers to provide it. The customers don’t ask for it from brokers.
+# '''It is [[title transfer]]''':<ref>Or there is a wide-ranging right of [[reuse]], which makes it ''effectively'' title transfer.</ref> Therefore, whoever holds initial margin generally has it, to use as it sees fit, at all times. Where initial margin is posted away to a third party custodian with expressly ''no'' right of reuse, things are different.
+# '''It is held in [[safekeeping]] by a third party''': Again, if you don’t hold the margin, you can’t reuse it, are not meant to be able raise funds against it, it does not secure present [[indebtedness]],<ref>Okay, this is true of all initial margin. But where you don’t even hold it, there should not be the temptation, you know?</ref> it is there purely as a credit default mitigant.
+That starting point, therefore — “an {{isdaprov|Early Termination Date}} in respect of all {{isdaprov|Transaction}}s has occurred or been designated as the result of an {{isdaprov|Event of Default}} or {{imcsdprov|Access Condition}} with respect to the {{imcsdprov|Chargor}}” — is one buy-side counsel are unlikely to like, as it allow a {{imcsdprov|Secured Party}} to spring {{imcsdprov|Posted Credit Support (IM)}} ''out'' of the {{imcsdprov|Custodian}}’s possession at an arbitrary date at which time you do not know whether you are even owed anything. You don’t even know whether you are owed anything ''on'' the {{isdaprov|Early Termination Date}} for that matter (and since it is bilateral, nor, really should [[sell-side]] [[legal eagle]]s like it, either).
+''Or'' you can elect to let your {{imcsdprov|Control Agreement}} govern.
+===What would the JC suggest?===
+If you can resist the urge to fire them at ISDA’s headquarters, you can damn the torpedoes and take the [[JC]]’s recommendation, as discussed below.