Fish or cut bait
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Hedge Funds & Prime Brokerage Anatomy™
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“Use it or lose it”, to use an easier vernacular.
When you have a good maul going forward, but momentum stalls, and it looks like someone might have their hands on your ball, the referee might call fish or cut bait to stop your additional termination event hanging on indefinitely and freaking your client out.
So, for example, you would have to exercise your rights following a NAV trigger within, say, 30 days.
Clients say, not unreasonably, “Look, I don’t want a Sword of Damocles hanging indefinitely over my head. If I am in the shtook, at least be prompt about deciding what to do about it. And look — if you have managed to survive for a month without closing me out, can’t we assume you can survive indefinitely that way? I don’t want you coming back nine months from now, just because you’ve had a bad day, and closing me out on account of this silly NAV trigger, do I?”
But a credit officer’s lot is not a happy one. She has wound up working in credit, for one thing. That can hardly have been the plan. Plus she is generally overworked, under-appreciated, under-resourced and generally beset by existential doubts — for that is in large part why she became a credit officer in the first place. She will say a fish or cut bait clause make her life harder: the cut-off time is inevitably arbitrary (true — but isn’t life generally arbitrary?), what counts as an ATE is often ambiguous (was it an ATE? Did they exceed the Threshold Amount?) and in any weather it is hard to calculate (30 days from the actual event, or when you knew of the event, or when you ought reasonably to have known about it, and so on), and undoubtedly some bright spark will want to have a grace period, or carve out securities financing settlements and, in any case, at the time one is invoked, the world will be off its axis, age-old institutions will be in ruins, the head of risk will be running around with his hair on fire, and the fog or war will be thick enough to contrive confusion, angst and resentment to delay any close-out decision for easily the three or four weeks necessary to run down the fish or cut bait period.
And in any case, if you have committed an event of default, you are hardly the one who should be calling shots about when and whether I close you out, are you?
Since no-one exercises NAV triggers anyway - well - have you ever? You are best to just shoot yourself before the negotiation starts.
The JC’s fish or cut bait trick
So here’s our solution to merge these issues.
- Make the fish or cut bait provision run for a month from the point when the defaulting party categorically notifies the innocent party, in writing, that it has committed an event of default and wishes the fish or cut bait period to start running.
This gets all incentives the right way around.
- Firstly. the defaulting party has to concede all the doubts and difficulties that might exercise the innocent party about whether it can pull the trigger or not. The defaulting party says, “friend, you’ve got me. Bang to rights.” There is no sneaking around, keeping a low profile and hoping the innocent party doesn't notice or can’t get organised in time.
- Secondly, the commencement of the period is also crystal clear, and there is no chance of the innocent party being inadvertently asleep at the switch.
- Thirdly, it encourages clear, open and early communication between the parties. It opens a channel of communication. Often a broker will be very accommodating and will help a distressed client to reduce its positions to avoid a close-out. Brokers don’t actually want to close their clients out. That is the last thing they want. This fact seems lost on many buy-side negotiators.
- Lastly, it gives a decent period of time for the credit officer’s steam punk machination to go through its motions — whilst at the same time making them as straightforward to go through as possible. “we know we have a default event, we know we can close out, we have a line of dialog to the client, we have 25 days left to make and communicate the decision.”