Bankruptcy shenanigans
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Banking basics
A recap of a few things you’d think financial professionals ought to know
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Bankruptcy shenanigans
/ˈbæŋkrəptsi ˈʃænən əˈɡɛnz/ (n.)
A collective noun to describe all the phantoms, phantasms and night sweat horrors that plague the deeper oubliettes in the minds of Basel Committee members when contemplating what might happen to swap dealers when faced with failing counterparties in foreign jurisdictions who go through the phase transition from solvency into bankruptcy.
Zero-hour rules, disappearing safe harbors, ERISA netting, mendacious cherry-picking bankruptcy administrators: any of that catalogue of hypothetical horrors that propel and justify the worldwide military-industrial netting complex.
These rules, however weird, have limited impact on most kinds of contracts. Master trading agreements — any kind of facility for serial wagering, really — is its own special category of pain.
Why?
Well in most cases a merchant’s undischarged contractual relationship with an aspiring bankrupt follows a similar pattern: discrete expectations to be paid something in the future as deferred consideration for something already supplied. This accounts for trade creditors, lending banks, utilities, even futures clearers. Where there are multiple discrete transactions between the same parties, they tend to be the same way around: service providers provide services, suppliers supply goods, banks provide money. It is unusual — not unheard-of, but still, rare — for a consumer to be providing goods to a supplier.
This being the case, a bankrupt’s creditors are already in the soup, whatever the bankruptcy laws say. Their claim is already defined. Their problem is not that they cannot now legally insist on having their money back, but that the bankrupt does not have enough money to pay them back in the first place. This is not a legal consequence, but a brute fact of the universe. The bankruptcy shenanigans an administrator is entitled to set off can’t make things a lot worse — indeed, they are designed to make things better, by ensuring everyone gets a fair piece of the pie.
Master trading arrangements are weird. Firstly, being speculative punts, transactions can and do go both ways. The same transaction can go both ways. So the “trade creditor can find itself owed money here, and owing money there. This is unusual. More sophisticated bankruptcy regimes (such as the UK and Switzerland) oblige administrator ls to set off opposing liabilities — but it is an unusual enough scenario that many jurisdictions do not.
Secondly, the liability under a derivative is not stable or predictable. It is tossed around line a ketch in an angry sea, by reference to matters entirely out of the control of the parties. Again, this is unusual for commercial contracts. If you make a loan, you know how much you are owed. Ditto, if you supply goods. The variability is minimal (discounting to take account of prevailing interest rates). To realise the value of a volatile derivative, you have to close it out. This is not just a recovery action that night give you a headstart against other creditors — this actually defines your total claim. Zero hour rules designed to stop normal creditors getting a jump on others for their existing claims stop derivatives counterparties even defining what their claim is. It stops them going off risk to the market situation the derivative references.
there can be a lot of transactions.