Dispute Resolution - VM CSA Provision

ISDA 2016 English Law VM Credit Support Annex A Jolly Contrarian owner’s manual™ Go premium Crosscheck: For corresponding provisions in other CSAs see the table 👇 Dispute Resolution in a Nutshell™ The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack. Original text: edit 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. The varieties of ISDA CSA Subject 1994 NY 1995 Eng 2016 VM NY 2016 VM Eng 2018 IM Eng Preamble Pre Pre Pre Pre Pre Interpretation 1 1 1 1 1 Security Interest 2 - 2 - 2 Credit Support Obligations 3 2 3 2 3 Transfers, Calculations and Exchanges - 3 - 3 - Conditions Precedent, Transfer Timing, Calculations and Substitutions 4 - 4 - 4 Dispute Resolution 5 4 5 4 5 Holding and Using Posted Collateral 6 - 6 - 6 Transfer of Title, No Security Interest - 5 - 5 - Events of Default 7 6 7 6 7 Rights and Remedies 8 - 8 - 7 Representations 9 7 9 7 9 Expenses 10 8 10 8 10 Miscellaneous 11 9 11 9 11 Definitions 12 10 12 10 12 Elections and Variables 13 11 13 11 13 Resources and Navigation Index: Click ᐅ to expand: 1994 NY CSA 1995 CSA 2016 VM CSA

Overview

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1994 CSA (NY) v 1995 CSA (English): Largely equivalent, as this comparison should tell you. Things that are different are:

In the 1994 NY version: the paragraph formatting is an absolute shower, and for reasons known best to itself, ISDA’s crack drafting squad™ felt compelled to add “(or Swap Transaction)” after the word “Transaction” wherever it appears.

In the 1995 UK version: “Transfer” is not a defined term and there is a “No Event of Default” subclause (seeing as the 1995 CSA is a Transaction under the ISDA, whereas the 1994 NY CSA is not.

1995 CSA v 2016 VM CSA (English law): But for a subsection dealing with what should happen if you are on the 1992 ISDA and not the 2002 ISDA (which in 1995, had not been invented), they are functionally the same. Here is a comparison.

1994 CSA v 2016 NY VM CSA (NY law): But for a similar subsection dealing with what should happen if you are on the 1992 ISDA and not the 2002 ISDA (which in 1995, had not been invented), the OG CSA and VM CSA under NY law are functionally the same. Here is a comparison.

2016 VM CSA v 2018 IM CSD (English law): Similar again, without the agonising over the edition of the ISDA Master Agreement you are using — possibly because it is not a Transaction under either of them?), but yet disowning the possibility of an Event of Default for non-payment in the event of a collateral dispute. So that is a bit flummoxing. But I bet there is a reason. comparison

Summary

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In the modern CSAs ISDA’s crack drafting squad™ not only passed up the opportunity to make this unused-in-practice language simpler but, rather, made it worse, by providing extravagant alternatives for 2002 ISDA and 1992 ISDA close-out methodologies.

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. The dispute can be as to the value of one of two things: the posted (or to-be-transferred) Eligible Credit Support, or the Transaction Exposure).

Credit Support Value

Let’s take the easy one first: Eligible Credit Support. If you are on a cash-only single-currency VM CSAm then there’s not really much to talk about here. What is the Value, in the Base Currency, of an amount in that Base Currency?. It’s not exactly a stumper, is it?

If you are still on an Original Gangsta CSA or you have insisted upon posting bonds and whatnot as margin, then — depending on how funky the Eligibility criteria are — you have more or less probability of swinging into a dispute. This is why most counterparties prefer liquid, highly-rated corporate and government debt. There is less to get into an argument about.

Transaction Exposure

The Transaction Exposure has — potentially — a different complexion. You can’t solve for it by just taking observable, liquid collateral: it is inherent in the Transaction itself.

While some asset classes (e.g., FX, equity derivatives) are mainly 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 proprietary model which is so amazing we’re not going to share with our competitor anyway.”

This is less common now 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, where you do see it, you have a bigger problem: if it is so complex only this guy’s Excel spreadsheet can possibly understand, that is your oh-oh moment right there: tell me: did he show you any backtesting to get you across the line?

The self-help model, coaches and horses etc.

But doesn’t this “self-help” valuation model drive a coach and horses through the carefully constructed Calculation Agent language about which the dealer has just threatened to die in a ditch?

It may seem so, but in practice no.

• The CSA’s dispute mechanism, while fulsome, reflects the uncynical attitude of yesteryear with its quaint aspirations that third party Reference Market-Makers will be prepared to lift the merest finger to help a fellow market participant out.
• They won’t. If you can find one Reference Market-maker to quote you a price, sing hosannahs: if you get four of the blighters to be looking out for further signs of the Rapture. In providing firm quotations to be dissected, arithmetically averaged and arranged for the delight of all we are relying on the better nature of a professional dealer whom a moment’s reflection should tell you doesn’t have a better nature. No Reference Market-maker will provide a quote, as it brings them no benefit (they can’t get a trade out of it) and saddles them with risk, namely the fear that one’s well-intended helping out is later portrayed as bad faith, negligence or has somehow caused compensatable harm to the interests of another market participant you didn’t even know had an interest.

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.

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• JC’s “nutshell” summary of the clause
• Background reading and long-form essays

See also

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