Bankruptcy shenanigans
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Banking basics
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Bankruptcy shenanigans
/ˈbæŋkrəptsi ˈʃænən əˈɡɛnz/ (n.)
A collective noun to describe all the phantoms, phantasms and night sweat horrors that plague the deeper oubliettes in the minds of Basel Committee members — and their respresenatives on Earth, credit officers — when contemplating what might happen to swap dealers who face failing customers in foreign jurisdictions who go through the phase transition from solvency into bankruptcy.
Zero-hour rules, disappearing safe harbors, ERISA netting, mendacious cherry-picking bankruptcy administrators: any of that catalogue of hypothetical horrors that propel and justify the worldwide military-industrial netting complex.
These rules, however weird, have limited impact on most kinds of contracts. Master trading agreements — any kind of facility for serial wagering, really — is its own special category of pain.
Why?
Well, in most cases a merchant’s undischarged contractual relationship with an aspiring bankrupt follows a similar pattern: it has discrete expectations to be paid amounts in the future as deferred consideration for one or more items the merchant has already supplied.
This scenario accounts for suppliers, trades people, service providers, lending banks, utilities, even futures clearers: where the “suppliers” have executed multiple discrete transactions with the same customer, the transactions all tend to be the same way around: service providers provide services, suppliers supply goods, banks provide money. Customer pays for it — later.
It is unusual — not unheard-of, but still very rare — for the consumer to be providing goods to the supplier.[1]
This being the case, a bankrupt’s ordinary creditors are already in the soup, whatever the bankruptcy laws say. They know what they are owed: their claim is already defined. Their problem is not the legal one, that they cannot take formal action to get their money, but that practical one that the bankrupt does not have the money to pay them in the first place.
This is not a legal consequence, but a brute fact of the universe. No contract, however magic, can fix it. The cupboard is bare. No amount of bankruptcy shenanigans can make things a lot worse than they already are: indeed, the point of bankruptcy shenanigans is to make things better, by ensuring everyone gets a fair piece of the pie.
Master trading arrangements are weird. Firstly, being speculative punts, Transactions can and do go both ways. The same Transaction can go both ways. So the “trade creditor” can find itself owed money here, and owing money there. This is unusual. More sophisticated bankruptcy regimes (such as the UK and Switzerland) oblige administrators to set off opposing liabilities from the same counterparty — but it is an unusual enough scenario that many jurisdictions do not.
Secondly, the liability under a derivative is not stable or predictable. It is tossed around like a ketch on an angry sea, by reference to matters entirely beyond the parties’s control. Again, this is unusual for commercial contracts: if you make a loan, you know how much you are owed. Ditto, if you supply goods. Any variability in your claim is minimal (largely a fluctuating discount rate to take account of prevailing interest rates).
But to realise the value, now, of a volatile derivative due to expire some point in the future, you have to close it out. This is not just a recovery action that might give you an unfair head-start against other creditors: closing out actually crystallises and defines your total claim.
Zero-hour rules designed to stop normal creditors getting a jump on others for their existing claims also stop derivatives counterparties even defining what their claim is. It stops them going off risk to the market situation the derivative references. This is a much more problematic thing. A dealer may not, right now, be in the soup. Crystallising now might mean the dealer owes the bankrupt. (This is one reason why dealers don’t like automatic early termination).
See also
- ↑ A customer with her own solar panels who supplies electricity back to the grid? A customer who has bought on sale or return terms?