Transfers, Calculations and Exchanges - VM CSA Provision

2016 ISDA Credit Support Annex (VM) (English law) A Jolly Contrarian owner’s manual™ Resources and navigation Resources Full wikitext | Nutshell wikitext Navigation 1 (Interpretation) | 2 (Credit Support Obligations) | 3 (Transfers, Calculations and Exchanges) | 4 (Dispute Resolution) | 5 (Title Transfer etc) | 6 (Default) | 7 (Representation) | 8 (Expenses) | 9 (Miscellaneous) | 10 (Definitions) | 11 (Elections and Variables) Index: Click ᐅ to expand: 2016 VM CSA 2018 CSD 1995 CSA Paragraph 4 in a Nutshell™ Use at your own risk, campers! 4 Dispute Resolution 4(a) Disputed Calculations or Valuations. If a Disputing Party disputes any collateral call (the Value of either the Exposure or the Credit Support being transferred): it must give notice by close of business on the date the transfer is due (if a Delivery Amount (VM) or Return Amount (VM)) or, the Local Business Day following the date of transfer (if a transfer of Eligible Credit Support (VM) or Equivalent Credit Support (VM)); it must transfer any undisputed amount by close of business on the date the transfer is due; the parties will try resolve the dispute. If by the Resolution Time they haven’t: Disputes as to Exposure: the Valuation Agent will recalculate the disputed portion of the Exposure as of the Recalculation Date by: averaging mid-market quotations for the Market Quotation from four Reference Market-makers (if a 1992 ISDA-style close out mechanism); or from four third parties for the Close-out Amount (for a 2002 ISDA-style close out mechanism), in either case from those parties who will provide one (and if none will, the Valuation Agent’s original calculations will stand); and calculating the outstanding Credit Support Balance as per Paragraph 11(f)(ii); Disputes as to Credit Support Value: recalculating the Value as of the date of transfer. The Valuation Agent will notify each party by the Notification Time on the Local Business Day following the Resolution Time. Then the appropriate transfer has to be made. 4(b) No Event of Default. A Party’s failure to meet a collateral call which it is disputing under Paragraph 4(a) will not be an Event of Default while the dispute resolution procedures are in train. Once completed, of course, a failure to transfer by the due date will again be a Failure to Pay or Deliver. view template Full text of Paragraph 4 Paragraph 4. Dispute Resolution 4(a) Disputed Calculations or Valuations. If a party (a “Disputing Party”) reasonably disputes (I) the Valuation Agent’s calculation of a Delivery Amount (VM) or a Return Amount (VM) or (II) the Value of any transfer of Eligible Credit Support (VM) or Equivalent Credit Support (VM), then: (1) the Disputing Party will notify the other party and the Valuation Agent (if the Valuation Agent is not the other party) not later than the close of business on the date that the transfer is due in respect of such Delivery Amount (VM) or Return Amount (VM) in the case of (I) above, or, in the case of (II) above, the Local Business Day following the date of transfer; (2) in the case of (I) above, the appropriate party will transfer the undisputed amount to the other party not later than the close of business on the date that the transfer is due in respect of such Delivery Amount (VM) or Return Amount (VM); (3) the parties will consult with each other in an attempt to resolve the dispute; and (4) if they fail to resolve the dispute by the Resolution Time, then: (i) in the case of a dispute involving a Delivery Amount (VM) or Return Amount (VM), unless otherwise specified in Paragraph 11, the Valuation Agent will recalculate the Exposure and the Value as of the Recalculation Date by: (A) utilising any calculations of that part of the Exposure attributable to the Covered Transactions that the parties have agreed are not in dispute; (B) (I) if this Agreement is a 1992 ISDA Master Agreement, calculating the Exposure for the Covered Transactions in dispute by seeking four actual quotations at midmarket from Reference Market-makers for purposes of calculating Market Quotation, and taking the arithmetic average of those obtained, or (II) if this Agreement is an ISDA 2002 Master Agreement or a 1992 ISDA Master Agreement in which the definition of Loss and/or Market Quotation has been amended (including where such amendment has occurred pursuant to the terms of a separate agreement or protocol) to reflect the definition of Close-out Amount from the pre-printed form of the ISDA 2002 Master Agreement as published by ISDA, calculating that part of the Exposure attributable to the Covered Transactions in dispute by seeking four actual quotations at mid-market from third parties for purposes of calculating the relevant Close-out Amount, and taking the arithmetic average of those obtained; provided that, in either case, if four quotations are not available for a particular Covered Transaction, then fewer than four quotations may be used for that Covered Transaction, and if no quotations are available for a particular Covered Transaction, then the Valuation Agent’s original calculations will be used for the Covered Transaction; and (C) utilising the procedures specified in Paragraph 11(f)(ii) for calculating the Value, if disputed, of the outstanding Credit Support Balance (VM); (ii) in the case of a dispute involving the Value of any transfer of Eligible Credit Support (VM) or Equivalent Credit Support (VM), the Valuation Agent will recalculate the Value as of the date of transfer pursuant to Paragraph 11(f)(ii). Following a recalculation pursuant to this Paragraph, the Valuation Agent will notify each party (or the other party, if the Valuation Agent is a party) as soon as possible but in any event not later than the Notification Time on the Local Business Day following the Resolution Time. The appropriate party will, upon demand following such notice given by the Valuation Agent or a resolution pursuant to (3) above and subject to Paragraph 3(a), make the appropriate transfer. 4(b) No Event of Default. The failure by a party to make a transfer of any amount which is the subject of a dispute to which Paragraph 4(a) applies will not constitute an Event of Default for as long as the procedures set out in this Paragraph 4 are being carried out. For the avoidance of doubt, upon completion of those procedures, Section 5(a)(i) of this Agreement will apply to any failure by a party to make a transfer required under the final sentence of Paragraph 4(a) on the relevant due date. view template Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

Content and comparisons

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Summary

In its 2016 VM CSA ISDA not only passed up the opportunity to make this unused-in-practice language simpler, but bloody-mindedly made it worse, by providing anally-retentive alternatives for 2002 ISDA and 1992 ISDA close-out methodologies. Which is just spectacular.

Disputed Calculations or Valuations is a topic that could unfurl like the flower of a deadly insect-eating nightshade if you let it.

DON’T LET IT.

What can be disputed?

The dispute can be as to one of two things:

• The Value of posted (or to-be-transferred) Eligible Credit Support; or
• The Transaction’s Value (when calculating Exposure).

Credit Support Value

Let's take the easy one first: Eligible Credit Support. If you are a smart sort of fellow who has moved onto a cash-only single-currency 2016 VM CSA then there’s not really much to argue about. What is the Value, in the Base Currency, of an amount in that Base Currency?. It’s not exactly a stumper, is it?

Transaction Exposure

The Transaction Exposure has — potentially — a different complexion. While some asset classes (FX, synthetic equity) are pretty liquid and observable and, in the same way, there is not much to argue about, others are not. The less liquid a transaction is (a tranched CDO³ anyone?), the more likely the broker is to refuse any dispute rights when carrying out its Calculation Agent function under the ISDA. The logic runs like this:

“Dude, this transaction is insanely complicated and we are marking to our own model. There’s no way some other guy will understand the trade or accurately value it, and in any case, the valuation relies on our own proprietary model which is so amazing we’re not going to share with our competitor anyway.”

This attitude is less common these days that swap trading is an unglamorous utility in a trading division which is only really there to support your wealth management offering, of course. And really, where you do see it, you have a bigger problem, which is you are entrusting your cash to some whizzkid who has sold you a pup. If it is so complex only this guy’s excel spreadsheet can possibly understand it it is like --- did he show you any backtesting to get you across the line?

So doesn’t the self-help valuation model under the vmcsa drive a coach and horses through the carefully constructed Calculation Agent language on which the broker counterparty has just insisted, to the point of threatening to die in a ditch about it?

It may seem so, but in practice no.

• Firstly, the dispute mechanism in the vmcsa, while fulsome, reflects the uncynical attitude of yesteryear in its aspirations for what third party Reference Market-Makers will be prepared to do to help a fellow market participant out.
• It depends on the better angels of a Reference Market-maker’s nature — nay, those of four of the blighters — in providing firm quotations to be dissected, arithmetically averaged and arranged for the delight of all. But a moment’s reflection should tell you that Reference Market-makers don’t have a better nature. They are certain not to provide a quote, which brings them no benefit (they can’t get a trade out of it) and saddles them with risk — albeit only the Chicken Licken sort of risk that assiduous attorneys like to busy themselves, namely the fear that one’s well-meaning bad faith or negligence has somehow caused compensatable harm to the interests of another market participant.

So all this careful language really boils down to “the party calling for collateral decides” which seems wildly one-sided until you realize that a trading relationship is — well — a relationship, and absent a material risk of outright failure (in which case, the value of mark-to-market exposures are a problem only when your counterpart has failed to honour them), the lure of a continued trading relationship, professional courtesy, and being a good egg — the commercial imperative, that is —are the practical mitigants against unconscionable behaviour.

Of course, none of these mitigants gives much scope for legal intercession, so a good lawyer tends to cast aspersions on them. [to be continued]

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General discussion

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See also

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References

1995 CSA and 2016 VM CSA: click for comparison

CSA transfer timings

This is how the timing works for CSA transfers.

Terminology check: to make this easy, we refer to both 2016 VM CSAs and 2016 VM CSAs as “2016 VM CSAs”. This cuts out a lot of “Delivery Amount and/or Return Amount as the case may be” nonsense. The date on which someone demands a 2016 VM CSA we call a “2016 VM CSA”.

To be clear, neither Demand Date nor 2016 VM CSA are “ISDA canon”.

Remember the 2016 VM CSA is simply the person making the demand.

1. Value 2016 VM CSA and 2016 VM CSA: Firstly, value what you are going to call: the 2016 VM CSA under para 2016 VM CSA or 2016 VM CSA. This is roughly 2016 VM CSA - 2016 VM CSA (or vice versa).
   1. Under 2016 VM CSA, the 2016 VM CSA will transfer 2016 VM CSA having a 2016 VM CSA as of the date of transfer of the 2016 VM CSA.
   2. Per the 2016 VM CSA provision, all calculations happen at the 2016 VM CSA. Fluctuations in value after that time won’t invalidate the 2016 VM CSA, but they may mean a party can immediately call for more 2016 VM CSA (that is, have another 2016 VM CSA).
   3. The 2016 VM CSA keys off the 2016 VM CSA.
2. 2016 VM CSA: On or promptly following any 2016 VM CSA (it need not be a 2016 VM CSA) on which the 2016 VM CSA has moved in its favour, one party may demand a 2016 VM CSA (para 2(a)) or a 2016 VM CSA (para 2(b)).
3. 2016 VM CSA: Under para 2016 VM CSA (2016 VM CSA) if the demand is received before the 2016 VM CSA on a 2016 VM CSA that is a 2016 VM CSA the transfer must be made by close of business on the related Regular Settlement Day. If received after the 2016 VM CSA or on a non-2016 VM CSA, the transfer must be made by close of business on the Regular Settlement Day relating to the day after the Demand Date.
4. Settlement Day: Here is where things differ materially between the 1995 CSA and the 2016 VM CSA.
   1. 1995 CSA: The Settlement Day for any day (whether or not it is a 2016 VM CSA) is:
      1. Cash: for cash, the next 2016 VM CSA and,
      2. Securities: for securities, the 2016 VM CSA after the date on which a trade in the relevant security, if effected on the day in question, would have been settled in accordance with customary practice.
   2. 2016 VM CSA: In the new world we have the new concept of the Regular Settlement Day, and this is the same Local Business Day as the Demand Date. The run-off text at the end of Paragraph 3(a) gives you a little more flex: if the demand came after the Notification Time, then you must make the transfer by close on the Regular Settlement Day for the next day. Just how the business days interact under the ISDA and CSA is about as complicated as string theory, by the way.