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| ===Section {{eqderivprov|12.7(c)}} and the curious question of the multiple {{eqderivprov|Determination Agent}}s===
| | The calculation of {{eqderivprov|Cancellation Amount}}s following {{eqderivprov|Extraordinary Event}}s is one of those classic negotiation oubliettes that opposing counsel will gladly fall into like Unlucky Alf falling into an open manhole. The [[JC]] has seen storied partners of [[Magic circle law firm|serious law firms]] get in quite the lather about this, treating the determination of these amounts as an opportunity for venal derivatives dealers opportunistically to rip hunks off their customers’ faces. |
| [[12.7(c) - Equity Derivatives Provision|Now]], here is a funny thing. | |
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| In its ever-unquenched thirst to cater for every conceivable eventuality, however inconceivable, [[the ’squad]] devoted themselves in Section {{eqderivprov|12.7(c)}}(ii) to the contingency that there might be ''two'' {{eqderivprov|Determining Parties}} appointed to hash out the {{eqderivprov|Cancellation Amount}} that applies for a {{eqderivprov|Transaction}}. This, we think, imagines some kind of collective [[co-calculation agent]] regime where the parties each have their own Man In Havana making independent calculations with the intention of split whatever difference there may be.
| | This is a wonderful [[narrative]], vouchsafing as it does [[tedious]], remunerative arguments that their clients may believe do them a great service, but it really need not be that complicated. |
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| But alas, having had the energy to contemplate this vanishingly remote scenario, our ninja friends didn’t have the diligence left to write out what should happen properly, and as a result, what Section {{eqderivprov|12.7(c)}}(ii) tells the co-{{eqderivprov|Determining Parties}} to do doesn’t make any sense.
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| In fairness, simply ''having'' co-{{eqderivprov|Determining Parties}} doesn’t make any sense, but that won’t do as an excuse: if you insist on contemplating something unnecessary, you should at least work it through properly, so [[negotiator]]s who fall into the trap of thinking you knew what you were doing when you drafted the option, and who therefore select it, don’t get themselves into bother later, which we regret to say they will, if they select two {{eqderivprov|Determining Parties}}. Not many do, but it is not unheard of.
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| But first things first.
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| ====Why it makes no sense to have two {{eqderivprov|Determining Parties}}====
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| Cast your mind back to the reason we have a {{eqderivprov|Determining Party}}, and not just the {{eqderivprov|Calculation Agent}}, in the first place. It is specifically for calculating {{eqderivprov|Cancellation Amount}}s when nixing a trade that has suffered a catastrophic {{eqderivprov|Additional Disruption Event}}:
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| {{quote|''...determination of a {{eqderivprov|Cancellation Amount}} is inextricably related to the [[hedge]] and — especially where there is a [[Additional Disruption Event - Equity Derivatives Provision|disrupted market]] – this is best to be calculated by the one whose problem it is to unwind that hedge: namely, the {{eqderivprov|Hedging Party}}. In theory (though ''almost'' never in practice) the {{eqderivprov|Hedging Party}} might not be the {{eqderivprov|Calculation Agent}}.''<ref>Yes, that ''is'' the JC quoting itself. Bite me — if you can’t be bothered seeing what else you can find on this topic on the Google, that is.</ref>}}
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| Now, remember what is going on here: we have a [[client]], going long or short some Equity underlier without actually having to buy it, and a [[swap dealer]], providing that exposure by using its deep connections into the world’s equities and futures markets. ''Customer'', that is to say, and ''service-provider''. The [[swap dealer]] has no skin in the game: it has no stake in the performance of the underlier. It will be hedging delta-one, usually by buying (or short-selling) the underlier outright. Other than to the extent that price keeps its customer happy and returning for more business, it is indifferent to the ''price'' of the underlier, as long as it can pass it on to its client. It has every incentive to get the best price it can: that is the [[commercial imperative]].
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| Now, if the {{eqderivprov|Transaction}} has been disrupted so badly it is to be cancelled, this means is hard to get a price in the underlier, That, in turn, means it is hard to liquidate the hedge. Whose problem is that? The {{eqderivprov|Hedging Party}}’s. It went out and bought the hedge, in fair times, and now it has to sell it, while times are foul.
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| To be clear this is no idle intellectual speculation: liquidating a hedge is not simply looking at some fantastical model dreamt up by the most delusional quant on the trading floor, arriving at some mad price that will ruin the client for nothing. ''No''. The {{eqderivprov|Hedging Party}} ''is actually long the risk''. It will have to crystallise real liability, using money from its own pocket to flatten out that risk. The amount it pays away is exactly what it will expect its client to suffer. That is the deal.<ref>Yes it is true that derivatives counterparties don’t, legally, ''have'' to hedge, but please, ladies and gentlemen: that is the academic theory. In practice, they absolutely do. The disconnect between a swap dealer’s hedge and the price of their derivative is a matter of interest for stamp-duty specialists only.</ref>
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| Running a synthetic equity business is mainly boring, often fraught, and on the odd occasion [[Archegos|terrifying]] job. Calculating {{eqderivprov|Cancellation Amount}}s upon market disruption counts, at least, as fraught. If the {{eqderivprov|Hedging Party}} can’t match its hedge executions with its client pricing, it will lose money. It occasionally escapes the buyside community, but this is not the idea. The dealer is does not expect to profit, or lose, from movements in the underlier: the point is to pass those onto the client, who has specifically signed up for them.
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| Accordingly, the dealer will be ''most'' unamused if a client asks it to consider an alternative price someone ''else'' has come up with to value its own hedge liquidation. This is like saying, to a football fan, “look, I know Crystal Palace lost to Scunthorpe in extra time at the weekend, but my mate 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 called off-side, so why don’t we call this 4:0 to Palace?”
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| The [[dealer]] will, tersely, say, “I am sure you have a great relationship with [[Wickliffe Hampton]] and everything, but I could not care a row of buttons where ''they'' see the notional value of ''my'' hedge. ''They'' don’t have to sell it. ''I'' do. The price ''I'' see is X. Now, if your buddies at [[Wickliffe Hampton]] are prepared to make ''me'' a [[firm bid]] at Y to buy my actual hedge, from me, then I am listening. Otherwise, the price I see is X.”
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| ====But it is {{eqderivprov|Determining Party}}, not {{eqderivprov|Hedging Party}}====
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| The truly stubborn buy-side agitant will persist: “if this is really about who is the actual {{eqderivprov|Hedging Party}}, why doesn’t it just say “{{eqderivprov|Hedging Party}}”? Why do we need a new definition of {{eqderivprov|Determining Party}}? It isn’t used for anything else. Your beloved ’squad doesn’t make these things up for the sake of it, after all.”
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| The galling fact is that we cannot explain this. Our best guess is yet more unnecessary over-elaboration on {{icds}}’s part — it may not have made a difference (and might have avoided this very article) had [[the ’squad]] ''not'' created an extra label, but we are where we are. It is possible, we suppose that the dealer hedges with a swap, and the actual price discovery happens away from the {{eqderivprov|Hedging Party}} along a chain somewhere). But that isn’t a very satisfactory answer.
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| ====Why, if you ''must'' insist on having two {{eqderivprov|Determining Parties}}, this clause doesn’t work====
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| This is the clincher. the co-{{eqderivprov|Determining Party}} language doesn’t work. Say we have, with heavy heart, acquiesced, and agreed two {{eqderivprov|Determining Parties}}. Let’s further say there has been an {{eqderivprov|Extraordinary Event}}, such that a {{eqderivprov|Cancellation Amount}} is required. We reach for Section {{eqderivprov|12.7(c)}}. Each {{eqderivprov|Determining Party}} does its thing: the [[swap dealer]]’s sees a price of 102, and the client’s agent sees 104.
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| Logic should say the number we are after is 103, yes? The ''average''. But, thought easily could have said that, that is not what Section 12.7(c) does say.
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| {{quote|“...an amount will be payable equal to one-half of the difference between the {{eqderivprov|Cancellation Amount}} of the party with the higher {{eqderivprov|Cancellation Amount}} (“X”) and the {{eqderivprov|Cancellation Amount}} of the party with the lower {{eqderivprov|Cancellation Amount}} (“Y”) and Y shall pay it to X.”}}
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| The difference between ''X'' and ''Y'' (104 - 102) is ''two''. ''Half'' of that difference is ''one''. If it is meant to yield a ''consensus'' single {{eqderivprov|Cancellation Amount}}, this, to put not too fine a point on it, is wildly, obviously, and patently ''wrong''.
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| ====“Equity vs Equity” swaps, maybe? Don’t think so.====
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| What could be going on? One thought we had — and it is a feeble, half-thought, so pay it little mind other than to dismiss it — is that this is meant to address a {{eqderivprov|Transaction}} where ''both'' parties are hedging separate equity risks: rather than the usual equity swap, which pays an {{eqderivprov|Equity Amount}} return against a {{isdadefsprov|Floating Amount}} return, the {{eqderivprov|Transaction}} is structured as two offsetting {{eqderivprov|Equity Amount}}s. This would at least justify there being two {{eqderivprov|Determining Parties}}, and it would also justify them using the ''difference'' between the values, rather than their ''average'' — but not ''half'' the difference between the values.
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| And even here, the concept doesn’t work: a {{eqderivprov|Cancellation Amount}} is crafted as the total termination amount for the ''whole'' {{eqderivprov|Transaction}}, not just a valuation of the {{eqderivprov|Equity Amount}} leg. Nor are such swaps otherwise contemplated in the {{eqdefs}}, seeing as there is a much easier way of achieving long exposure to one underlier and short exposure to another: just enter two vanilla {{eqderivprov|Transaction}}s, one long and one short.
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| ====Ok, how about the User’s Guide to the 2002 Equity Derivatives Definitions?====
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| Perhaps, you might thing, the User Guide sheds some light? Well, perhaps indeed. But alack: the little it has to say on the subject sheds light on one question only: that whoever wrote the User’s Guide<ref>Is it just me who finds the idea that ISDA contemplates just a solitary reader of its “User’s Guide”? And that that solitary reader is the JC? Mind you, it could be worse: the 2011 Equity Derivatives Definitions have ''no'' users!</ref> has no better clue to what is meant to be going on that anyone else. For it opines:
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| {{quote|“If there are two Determining Parties, each party will determine a Cancellation Amount ''and one half of the '''total''' of the Cancellation Amounts is payable''.”}}
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| This is, of course, not what Section 12.7(c) says at all. As we have noted, it says, “... an amount will be payable equal to one-half of the '''difference''' between the Cancellation Amount of the party with the higher Cancellation Amount (“X”) and the Cancellation Amount of the party with the lower Cancellation Amount (“Y”) ... ”
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| See also a [[Determining Party - Equity Derivatives Provision|discussion]] about why the User’s Guide indicates the {{eqderivprov|Determining Party}} really is meant to be the person who is doing the hedging.
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The calculation of Cancellation Amounts following Extraordinary Events is one of those classic negotiation oubliettes that opposing counsel will gladly fall into like Unlucky Alf falling into an open manhole. The JC has seen storied partners of serious law firms get in quite the lather about this, treating the determination of these amounts as an opportunity for venal derivatives dealers opportunistically to rip hunks off their customers’ faces.
This is a wonderful narrative, vouchsafing as it does tedious, remunerative arguments that their clients may believe do them a great service, but it really need not be that complicated.