Termination of a finance contract
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There is no more sacred time in the life of a commercial arrangement than our departure from its earthly clutch. We wish our relationships well, pray for their long life and a peaceful ultimate transition from them into the hereafter, but we know this is not always possible.
Commerce gives the lie to the idea that life is a zero-sum game. We will only strike a bargain if, on our own terms, each of us will be better off afterwards. That being the case, there need be no end to a commercial relationship: if we are flexible enough, open-minded enough, and good enough at playing the infinite game we can keep this positive feedback loop going indefinitely. Infinitely, even.
But things do not always work out. Therefore, we pack our trunk with tools and weapons with which, if needed, we can engineer an exit.
Customers and service providers
Now the great majority of financial contracts are between a “provider” on one side — a bank, broker or dealer who provides money outright, against an asset, or an exposure to an asset — and a “customer” on the other. And the customer is always king: these arrangements exist for the customer’s major benefit: the provider’s net interest is limited to flattening its financial exposure under the contract and earning a fee, commission or economic rent of some kind.
Generally, the customer can always exit a financial contract whenever it wants by paying outstanding fees and whatever the provider needs to terminate the arrangements it made to provide the service rendered — its hedge break costs. This makes the whole business worth the provider’s while.
But, all else being equal, the provider cannot just exit without the customer’s permission. In as much as a financial contract has a fixed term, therefore, it binds the provider and not the customer. Hence, the provider must have a suite of weapons it can use to get out of a financial contract where it can no longer vouchsafe its expected financial return. These fall into a bunch of different categories.
Categories of termination
We would put these “exit scenarios” into three categories: terminations “without cause”[1] terminations due to unforeseen external events; and terminations due to counterparty failure. This last category — which we might also label “default” — in turn breaks into two: non-performance and credit deterioration. There is also an odd category of pseudo-termination rights that a dealer must have, but would never insist on using and, curiously, relate to concerns about its own solvency.
Without cause
Terminations without cause: they arise just because — no fault, no pressing need; just a gradual drifting apart of interests. As we grow in life, the things we value change. Passions of youth dampen, we tend more towards songs of experience than those of innocent exuberance, and we sing those to a different tune. Here we prescribe a notice period long enough to allow our counterparty to make alternative arrangements it needs to keep its own house in order, but otherwise, we wish each other well and carry along on our way.
Pseudo termination rights
There is a fourth category: the pseudo-termination right: this is a right the provider needs for formalistic or regulatory reasons, but which it never expects to actually use. These may include, for example, a dealer’s right to terminate on say 30 days’ notice from a synthetic equity derivative contract — this entitles the dealer to treat the exposure as a “short-term obligation” for regulatory purposes, dramatically reducing its capital cost of offering the business, but it is not aright the dealer would ever expect to exercise except in the direst of circumstances (where its own survival was threatened).
See also
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References
- ↑ You hear these described as “no-fault” terminations, but there is no fault in a termination brought about by unforeseen externalities, either.