Downgrading

Downgrading personnel is the process of finding a cheaper unit to do the same job. It is mean to save money and avoid the tiresome and messy human error that otherwise infect the flawless, crystalline system.

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Once upon a time

When the JC was but a stripling clerk, his senior partner assigned to him the job of reviewing this speculative new contract for an important finance client. This was in about 1995.

“The client will take potentially massive, long-tenor exposures under this new contract,” said he, knocking his pipe out on the young contrarian’s head. “Potentially ruinous ones. It is our sacred duty to make sure our client is safe! And that means —”

The partner’s eyes glittered.

“Daily mark-to-market variation margin?” I offered.

“No, boy, no!” he shrieked. “No, no, no!”

For a moment I was flummoxed, but then I saw in those black eyes the fierce gleam that comes from countenancing vast professional fees, and I understood.

“Billings!”

He held out his hand. In his palm: a red pill and a blue pill.

I regarded the document, and then the pills. The contract was slim, rendered on crisp onionskin. It had a five-part Schedule at the back. It was beautiful — ineffable — alien in its obliqueness. I mouthed its title, printed in block capitals across the front page: “Eye-ess-dee-aye”.

Exactly! said he. “A sw-æp agreement!”

I flipped the pages. My mind whirred with the other-worldly concepts I beheld: Single Agreement. Merger Without Assumption. Netting. Gross-Up. Default Under Specified Transaction. What could they all mean? It meant nothing to me. I didn’t — couldn’t — understand. How could I? But II felt it, deep in my fibre. I needed to know.

I took the red pill.

And, ladies and gentlemen, that is how we find ourselves looking at each other today, through the vale of tears and resentment we both know as a liquid crystal display. Yes: it is a matrix, and I am stuck in here. But, look: don’t worry about me: I can’t bear mawkish sentimentality. And I wouldn’t feel sorry for you if our positions were reversed. And, after all, I shall outlive you all.

What does this all mean?

Ok: enough of the cod-philosophical sci-fi. The notional amount of OTC derivatives traded in 1995, when I took my red pill, was roughly USD12 trillion. By 2018 it was nudging USD600 trillion. Six hundred trillion bucks.

In any case, an ISDA Master Agreement was once a rare and special beast. Nowadays it isn’t — financial institutions negotiate thousands of them every year — and, for fifteen or twenty years management consultants all over the globe have pored over the costs of negotiation to see how to bring them down. This means some kind of triage. The partner flipped it to the associate, to the trainee, to the in-house lawyer, to the ISDA negotiator, to the operations clerk.

It has led to the great dogma of contract negotiation: We must do this cheaper. The cry went out. “Percy! Find me people cheaper units to negotiate these contracts!”

First they came for the antipodeans. Then for school leavers in former satellite states of the Soviet Union. Then for the entrepreneurial youngsters in Northern Ireland. Then the unemployed of Bristol. Now they are scouring the outer suburbs of Birmingham. Commercial law firms are not often instructed to thrash out an ISDA any more.

But throughout it all the ISDA Master Agreement, with its different editions, its insufferable tax representations, its schedule, annexes, protocols, definitions booklets — every word of which rendered in committee-crafted 19th century prose — remained the same. Never once did anyone ask: do we really need all of this? Is it really feasible to expect school-leavers from Bratislava to wade through all this? Could we not make it simpler?

See also

• Private practice
• Close-out Netting: the Red Flag Act of finance.
• The great dogma of contract negotiation