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Events of Default - GMSLA Provision: Difference between revisions

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→‎What is the protection for an expected recipient if a delivery failure occurs?
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Deliveries in stock lending typically occur free of payment, with the cash moving after the shares are confirmed as settling.  This is for 3 principal reasons:
Deliveries in stock lending typically occur free of payment, with the cash moving after the shares are confirmed as settling.  This is for 3 principal reasons:
1. The cash collateral is frequently not in the same currency as the domestic market of the security, meaning that a delivery versus payment could not be arranged.
#. The cash collateral is frequently not in the same currency as the domestic market of the security, meaning that a delivery versus payment could not be arranged.
2. Attempting to match payment instructions to delivery instructions on a DVP basis would increase an already high failure rate.
#. Attempting to match payment instructions to delivery instructions on a DVP basis would increase an already high failure rate.
3. The high failure rate means that if cash were due to move at the same time or prior to the shares moving, the cash would frequently be transferred against shares that fail.  As mentioned earlier, if the lender fails to deliver shares to initiate the trade, the normal intention of parties is that no loan would be initiated.  So it would be anomalous for cash to be transferred to the lender for a securities loan that might never occur.
#. The high failure rate means that if cash were due to move at the same time or prior to the shares moving, the cash would frequently be transferred against shares that fail.  As mentioned earlier, if the lender fails to deliver shares to initiate the trade, the normal intention of parties is that no loan would be initiated.  So it would be anomalous for cash to be transferred to the lender for a securities loan that might never occur.


In practice, each day market participants determine the securities and collateral that have settled and are currently held by each party, calculate the value of those securities and collateral at the most recent market close available to that party, and make a collateral call for any shortfall.  If a party were expecting a delivery of securities, it would not have delivered cash overnight when the securities were due to settle but would instead be waiting until the following day to pay the cash against a margin call by the deliverer.  If the securities were never delivered, the consequence would be that the amount of the margin call against the expected recipient would be reduced.  (Or if securities prices on other stock loans had moved in the expected recipient’s favour, the expected recipient’s call against the failed deliverer would be increased.)  If the failed stock loan were the only trade between the parties, then:  
In practice, each day market participants determine the securities and collateral that have settled and are currently held by each party, calculate the value of those securities and collateral at the most recent market close available to that party, and make a collateral call for any shortfall.  If a party were expecting a delivery of securities, it would not have delivered cash overnight when the securities were due to settle but would instead be waiting until the following day to pay the cash against a margin call by the deliverer.  If the securities were never delivered, the consequence would be that the amount of the margin call against the expected recipient would be reduced.  (Or if securities prices on other stock loans had moved in the expected recipient’s favour, the expected recipient’s call against the failed deliverer would be increased.)  If the failed stock loan were the only trade between the parties, then:  
(i) If the failure was by the lender at the start of the loan, no loan would be entered into, and neither party has any exposure.
#. If the failure was by the lender at the start of the loan, no loan would be entered into, and neither party has any exposure.
(ii) If the failure was by the borrower at the end of the loan, the lender would not return the cash, and each party has the same exposure that it did the previous day (other than market movements on the securities).  
#. If the failure was by the borrower at the end of the loan, the lender would not return the cash, and each party has the same exposure that it did the previous day (other than market movements on the securities).  


The correct approach is that under the OSLA agreement:
The correct approach is that under the OSLA agreement:
1. A delivery failure by a lender when initiating a loan has no consequence – it is neither an Event of Default, nor a breach of contract.
#. A delivery failure by a lender when initiating a loan has no consequence – it is neither an Event of Default, nor a breach of contract.
2. A redelivery failure by a borrower at the end of the loan is not an Event of Default.  Rather, the lender is free to buy in the securities using the procedure under section 9.4 of the GMSLA.
#. A redelivery failure by a borrower at the end of the loan is not an Event of Default.  Rather, the lender is free to buy in the securities using the procedure under section 9.4 of the GMSLA.
3. A failure by either party to deliver collateral when required is an Event of Default.
#. A failure by either party to deliver collateral when required is an Event of Default.


This correctly addresses the credit concerns that a party may justifiably have under a stock lending relationship, while also reflecting the intentions of the transacting parties when entering into securities loans.
This correctly addresses the credit concerns that a party may justifiably have under a stock lending relationship, while also reflecting the intentions of the transacting parties when entering into securities loans.
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