Template:Flawed asset capsule: Difference between revisions
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The most famous flawed asset clause is Section {{isdaprov|2(a)(iii)}} of the {{isdama}}. It entered the argot in a simpler, more peaceable time, when two-way, zero-threshold, daily margined {{tag|CSA}}s were a rather fantastical sight, and it was reasonably likely that a counterparty might be nursing a large unfunded mark-to-market liability which it would not want to have to fund just because the clot at the other end of the contract had gone belly-up. Closing out the contract would crystallise that liability, so the flawed asset provision allowed that innocent fellow to just stop performing hte contract altogether, rather than paying out its mark-to-market loss. | The most famous flawed asset clause is Section {{isdaprov|2(a)(iii)}} of the {{isdama}}. It entered the argot in a simpler, more peaceable time, when two-way, zero-threshold, daily margined {{tag|CSA}}s were a rather fantastical sight, and it was reasonably likely that a counterparty might be nursing a large unfunded mark-to-market liability which it would not want to have to fund just because the clot at the other end of the contract had gone belly-up. Closing out the contract would crystallise that liability, so the flawed asset provision allowed that innocent fellow to just stop performing hte contract altogether, rather than paying out its mark-to-market loss. | ||
That was then; 1987; they hadn’t even invented the {{ | That was then; 1987; they hadn’t even invented the {{csa}}. Even once they had, it would be common for a muscular [[broker/dealer]]s to insist on one-way margining: “You, no-name pipsqueak highly levered [[hedge fund]] type, are paying ''me'' variation margin; I, highly-capitalised, prudentially regulated<s>, balance-sheet levered</s> financial institution, am not paying ''you''.” | ||
Well, those days are gone, and bilateral zero-threshold margin arrangements are more or less obligatory nowadays, so it’s hard to see the justification for a [[flawed asset]] provision. But we still have one, and modish post-crisis threats by regulators worldwide to stamp them out seem, for the time being, to have come to nought. | Well, those days are gone, and bilateral zero-threshold margin arrangements are more or less obligatory nowadays, so it’s hard to see the justification for a [[flawed asset]] provision. But we still have one, and modish post-crisis threats by regulators worldwide to stamp them out seem, for the time being, to have come to nought. | ||
Revision as of 10:31, 28 June 2019
Following an event of default, a “flawed asset” provision allows an innocent, but out-of-the-money counterparty to a derivative or securities finance transaction to suspend performance of its obligations without terminating the transaction and thereby crystallising a mark-to-market loss.
The asset – a right to payment under the transaction – is “flawed” in the sense that it only become payable if the conditions precedent to payment are fulfilled.
The most famous flawed asset clause is Section 2(a)(iii) of the ISDA Master Agreement. It entered the argot in a simpler, more peaceable time, when two-way, zero-threshold, daily margined CSAs were a rather fantastical sight, and it was reasonably likely that a counterparty might be nursing a large unfunded mark-to-market liability which it would not want to have to fund just because the clot at the other end of the contract had gone belly-up. Closing out the contract would crystallise that liability, so the flawed asset provision allowed that innocent fellow to just stop performing hte contract altogether, rather than paying out its mark-to-market loss.
That was then; 1987; they hadn’t even invented the 1995 CSA. Even once they had, it would be common for a muscular broker/dealers to insist on one-way margining: “You, no-name pipsqueak highly levered hedge fund type, are paying me variation margin; I, highly-capitalised, prudentially regulated, balance-sheet levered financial institution, am not paying you.”
Well, those days are gone, and bilateral zero-threshold margin arrangements are more or less obligatory nowadays, so it’s hard to see the justification for a flawed asset provision. But we still have one, and modish post-crisis threats by regulators worldwide to stamp them out seem, for the time being, to have come to nought.