Template:Derivatives as specified indebtedness

Derivatives as Specified Indebtedness

Be wary of including derivatives or other non-debt-like money payment obligations in the definition of Specified Indebtedness, no matter how high a Threshold Amount. We would say never do it, but the wise minds of the credit department may well be beyond your calming influence, so you may not have a choice. But if you have a choice, don’t do it.

Cross Default aggregates up all individual defaults, so even though a single ISDA Master Agreement would be unlikely to have a net out-of-the-money MTM of anything like 3% of shareholders’ funds, a large number of individual transactions if aggregated may, particularly if you’re selective about which transactions you’re counting — which the language entitles you to be.

Thus, where you have a large number of small failures, you can still have a big problem. This is why you should also carve out deposits: operational failure or regulatory action can create an immediate problem, especially for banks.

Now it is true that you can provide the Specified Indebtedness represented by a master trading agreement can be calculated by reference to its net close-out amount, but this only really points up the imbalance between buy-side and sell-side. Sure, buy-side managers may have fifty or even a hundred ISDA Master Agreements but they will be split across dozens of different funds. Broker-dealers, on the other hand, will have hundreds of thousands of master agreements, all facing the same legal entity. Credit dudes: you are the wrong side of this risk, fellas.

Now seeing as most trading agreements are fully collateralised, and so don’t represent material indebtedness on a netted basis, it may be that even with hundreds of thousands of the blighters, no-one’s Threshold is ever seriously threatened. But if no threshold is ever at risk, then why are you including the ISDA Master Agreement in Specified Indebtedness in the first place?

O tempora. O paradox.