Dispute Resolution - VM CSA Provision

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2016 ISDA VM CSA Anatomy


In a NutshellTM Section 4:

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):

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.
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2016 ISDA VM CSA full text of Section 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.
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Related Agreements
Click here for the text of Section 4 in the 1995 English Law CSA
Click here for the text of Section 4 in the 2016 English Law VM CSA
Click here for the text of the equivalent, Section 5 in the 2016 NY Law VM CSA
Comparisons
Template:Csadiff 4
2016 English law VM CSA and 2016 NY Law VM CSA: click for comparison
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)

In its 2016 English law 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:

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 English law 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?[1]. 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[2] or negligence has somehow caused compensatable harm to the interests of another market participant[3].

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]

  1. Hint: it’s not a trick question
  2. I know this is a contradiction in terms.
  3. The best defence to such an action, if you were wondering, is not to act in bad faith and to be competent in what you do. But that’s as may be: Chicken Licken is really only the excuse one wheels out for not wasting time doing something for which you get no benefit.