Disputed Calculations or Valuations - CSA Provision
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.
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.
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:
- The Value of posted (or to-be-transferred) Eligible Credit Support; or
- The Transaction’s Value (when calculating Exposure).
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?. It’s not exactly a stumper, is it?
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 csa 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 csa, 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 or negligence has somehow caused compensatable harm to the interests of another market participant.
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]
- Hint: it’s not a trick question
- I know this is a contradiction in terms.
- 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.