Calculation Agent
Calculation Agent
/ˌkælkjʊˈleɪʃən ˈeɪʤənt/ (n.)
One who calculates things on behalf of contracting counterparties. In theory, under any kind of finance contract, but in practice, mainly in the ISDA and its extended fan-fiction universe (GMSLA, GMRA, DRV, FBF etc), and in the documentation of debt securities.
To be endlessly compared and contrasted with a “determination agent”, who determines things on behalf of contracting counterparties. Do “calculation” and “determination” differ? Not as far as this correspondent can see. You tend to say, perversely, that a Calculation Agent determines things, and a Determination Agent calculates things, but largely because elegant prose has a horror of repetition. But will that stop over-enthusiastic members of the bar waxing lengthily about how they do differ? it will not.[1]
In the ISDA
The ISDA Schedule has space to specify who the Calculation Agent should be but, curiously, gives scant hints as to what such an agent should do: the term isn’t otherwised defined — or even used — in either version of the ISDA Master Agreement. The role comes in to its own under the 1995 CSA and the various definitions booklets ISDA has published. The Calculation agent can differ from transaction to transaction, and while guileless negotiation teams may therefore spend a great deal of energy haggling fruitlessly about who should be the Calculation Agent, and what rights the other poor sap should have to challenge its determinations, in practice it will be the dealer.
As well as in the ISDA Master Agreement, the term is defined separately in each definition booklet, giving everyone a nice opportunity for some clarifying hierarchy action:
- In the 2002 ISDA Equity Derivatives Definitions at Section 1.40;
- In the 2006 ISDA Fund Derivatives Definitions (in virtually identical terms to the 2002 ISDA Equity Derivatives Definitions) at Section 1.27;
- In the 2005 ISDA Commodity Definitions at greater length in Section 4.5;
Co-calculation agent
There’s an old saying:
A co-calculation agent is no calculation agent.
However superficially neat this might seem to the age-old valuation dilemma of who should price the trade, it suffers in one important respect: unless the parties agree on the determination, the parties — er — won't agree on the determination. And then what do you do?
Disputing a Calculation Agent’s determinations
One of the great old saws of negotiation in any capital markets transaction is what to do if you don’t like the number the Calculation Agent comes up with.
This springs from the ancient, primal fear that flutters in the breast of every buy-side legal eagle, and which is best articulated thus: All swap dealers are profit-obsessed predators. They eat their own young, so will hardly blanche about eating yours.
They will, thus, not pause to breathe before ripping clients’ faces from their skulls should the merest opportunity to do so arise. Derivatives, we know, are financial weapons of mass destruction™ even on a good day, so giving one of those dastardly dealers the unilateral right to determine values on the economic equivalent of an ICBM without any comeback would be insane.
Therefore, I must have a mechanic to dispute a calculation my dealer makes that seems “off”.
Now, to be fair, there was a time, in living memory, when swap dealers would rip off their clients’ faces at the merest opportunity, in some markets. “Cheapest to deliver” options in managed CDO portfolios spring unhappily to mind. Banks used to “prop trade” a lot more than they do now. The year or our lord 2006 was a wild time. There are different regulations now: capital rules, clearing obligations, prop-trading restrictions, and best execution obligations. Dealers play much more of an agency role now. They act like brokers ought to: they execute as riskless principals, they earn their keep from commissions, and not by trading against their clients. In observable, liquid markets, clients can see for themselves whether they are getting good prices, and can take their business elsewhere if they are not.
Yet we are still beset by fear of dealer mendacity.
But even if they were justified, the dispute mechanism our learned friends habitually confect boil down to seeking prices from other “reference dealers”. The exact method can be baroque: appeals to Law Society presidents, competing panels of reference dealers, fallbacks dealers, co-calculation agents, discarding outliers, splitting differences and so on, but each is predicated on the idea that a disinterested market participant — who is still, remember, a rapacious dealer, just not one with a dog in the fight — will be less inclined to tear your face from the bone than the one with whom you have had a fruitful twenty-year relationship. This feels wishful.
As does the idea that a disinterested dealer will have any interest in offering a price at all. Why would it? What does it have to gain from reverse engineering a historical market value for a a security it will not actually get to trade?
This is quite different from the case of your actual dealer. It will base its marks on where it has actually executed its own delta-hedge. In other words, these are prices at which it has actually traded, and for which it has off-setting liability. Why would it ever accept a hypothetical price from a disinterested third party over its own actually traded price?
The real answer to calculation agent disputes is the commercial imperative. Dealers trade countless swaps every day. Their business viability depends on satisfied old customers coming back and placing more orders. Customers who have had their faces ripped off don’t do that.
We sense there will be buyside legal-eagles out there who are not persuaded by this. We know there are, in fact: their Byzantine valuation dispute mechanisms pepper ISDA portfolios from New York to Tokyo. If you are one of them, here is a question: when did your client last actually invoke a dispute mechanism in anger?
How strongly each feels about its right to query or dispute the Calculation Agent’s determinations will depend on the sort of products they’re expecting to trade: FX and simple equity derivatives have deep, liquid, observable markets, and as there’s little scope for picking a fight, a dealer Calculation Agent may not be bothered about ceding rights to dispute its calculations. Expect a different reaction should you seek to second-guess your dealer’s marks on exotic credit derivatives, on the other hand. These rely enormously on the dealer’s internal models, pricing curves and other kinds of idiosyncratic financial alchemy that are almost certainly unique to the dealer in question.
See also
References
- ↑ Pedants will note the different roles played by the Calculation Agent and the Determining Party in the 2002 ISDA Equity Derivatives Definitions.