Equivalent

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Warning: metaphysical area approaching. Approach stacked turtles with care.

AKA fungible. When you get given something — credit support, for example — that at some point you’ll have to give back, the deal is you have to give an identical thing back.

Now, when it comes to return it, dilemma: you’ve been mucking around with it. You don’t still have “it”. You could go and buy a new “it” and return that, but the exact old “it” they gave you — that’s goneski.

Look: you got it by title transfer, so it was yours to muck around with, wasn’t it? Or, look, so they only pledged it to you, but you had the right to rehypothecate it, didn’t you? You were allowed to muck around with it.[1]

All true. And just so. In any case, you want to hand over something that is identical to, but isn’t exactly the something that you were given. But it is exactly the same. For most purposes in this day and age that is fine, and indeed will support your title transfer analysis, should you be in the market for a true sale opinion.

When, as all of them these days are, your securities are dematerialised and held in a clearing system, this might seem an arid distinction, but it is one you must keep in mind when considering the fundamentals of our business — close-out netting, stock lending, rehypothecation (anything that involves a title transfer collateral arrangement, really) — lest the whole intellectual superstructure of modern credit risk mitigation should collapse before your eyes. Or on you.

Equivalent” isn’t just “similar”

You may come across someone (in OTC Clearing/CCP space) who wants to modify “equivalent” to mean not just fungible securities of the same Series/ISIN, but “similar ones” – same issuer, but different maturity, and under a different ISIN etc.

Resist this. It is likely to have arisen by way of misapprehension. In most master docs, “equivalent” is carefully defined to be exactly fungible [2]but at the gallop at which most collateral operations managers’ working days pass, they may have missed this, labouring instead under the illusion (based on its ordinary dictionary meaning) that “equivalent” allows redelivery of non-fungible securities of a “similar” type. They may even defend their misapprehension. “Yeah, they may protest, “but what if there’s some illiquidity in the market?”

But — well, you have that exact risk across your entire ISDA collateral book, so it’s a bit late. In practice, if there is a market disruption and you can’t get hold of the necessary collateral, as long as it doesn’t coincide with your own credit deterioration[3], you should be able to hash it out.

And if you are worried about it, go for a cash-only CSA — these days most are — or don’t allow potentially illiquid assets as collateral, or just don’t reuse that asset.

Now there may be a need for the “similar securities” concept in the OTC to CCP space that we haven’t yet divined, doubtful, but let’s say — but we should call that something else – perhaps “Similar Credit Support” – to differentiate it from “Equivalent Credit Support” which is still needed in the CSA to support the title transfer analysis.

See also

References

  1. Or, just as commonly and more innocuously, you held it in a dematerialised omnibus custody account, with fungible assets owned by other customers, and never did anything with it, but you still can’t tell whose bit is whose.
  2. See: 1995 English Law CSA: “Equivalent Credit Support”; 2010 GMSLA: Equivalent; Global Master Repurchase Agreement: Equivalent.
  3. I mean, imagine.