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Lehman Brothers International (Europe) v AG Financial Products, Inc.: Difference between revisions
Lehman Brothers International (Europe) v AG Financial Products, Inc. (view source)
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While there is no Loss concept in the {{2002ma}} this case is relevant in that a 2002-style “{{isdaprov|Close-out Amount}}” is ''broadly'' the same thing as a {{isdaprov|Loss}} calculation. | While there is no Loss concept in the {{2002ma}} this case is relevant in that a 2002-style “{{isdaprov|Close-out Amount}}” is ''broadly'' the same thing as a {{isdaprov|Loss}} calculation. | ||
The case concerns a portfolio of credit derivatives between LBIE and [[monoline insurer]] [[AG Financial Products]], which the judgment confusingly labels “Assured” — AG once stood for “Assured Guaranty” — even though AG was ''writing'' credit protection, not benefiting from it. | |||
In any case, LBIE created some tranched CLOs and mortgaged backed CDOs. AGFP wrote credit protection on the senior tranches. The CDOs “blew up” in the sense that every structured product in the world in 2008 blew up, as did LBIE and, nearly AGFP. LBIE having defaulted by Bankruptcy, AGFP (eventually) closed out its ISDA. As {{isda92prov|Non-Defaulting Party}}, AGFP was entitled to value its replacement cost and did so claimed it was owed $20m. LBIE said, “I’m sorry, you freaking ''what?''” and countered that the close-out value of the contracts was $485m, payable to ''LBIE''. | |||
Now, one can and at times of stress ''should'' expect a difference of opinion in the value of unfunded derivative contracts. That s natural. But a difference of half a yard? That is a ''lot''. | |||
Cue litigation. | |||
The first question, resolved in an earlier trial, was who had the burden of proving what. Crane J put this, as she put much in her judgment, drily: | |||
{{q|When this trial first started, the court was skeptical about how, given such a large discrepancy, Assured’s calculation could ever be reasonable. As the trial progressed, however, there was a growing realization that the marriage of catastrophic, historical financial circumstances with bespoke contractual terms, along with strong structural protections in the Securities, lent itself to the conclusion that at least LBIE’s calculations were not reasonable. ... Now, even with the benefit of that rebuttal case, and extensive post trial briefing, the court’s growing realization has crystallized to conclusion. LBIE’s valuation, that relied entirely on market prices its experts constructed for this litigation, was insufficient to meet LBIE’s burden to prove its own calculations were reasonable. }} | |||
What can we learn from this: | What can we learn from this: | ||
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This is, of course, because shots are not usually fired in the termination of an {{isdama}}. And we suspect the sorts of instruments traded under ISDAs are, by and large a lot more vanilla and liquid than tranched [[CDO]]s. | This is, of course, because shots are not usually fired in the termination of an {{isdama}}. And we suspect the sorts of instruments traded under ISDAs are, by and large a lot more vanilla and liquid than tranched [[CDO]]s. | ||
===When hair is on fire all bets are off=== | ===When hair is on fire all bets are off=== | ||
As we have written elsewhere, {{isdama}} was drafted by committee in a time of peace, is negotiated in a time of prosperity and with hopeful expectation, and is often closed out in a time of [[apocalypse]] when it is not just the {{isdaprov|Defaulting Party}} who is preparing to meet its maker, but the {{isdaprov|Non-Defaulting Party}} and, as like as not, those putative {{isda92prov|Reference Market-makers}} too. Lions are lying down with lambs, plagues of locusts swarm the land and risk officers’ grasp of commercial and economic fundamentals — tenuous at the best of time — disconnects from reality altogether. There was a passing | As we have written elsewhere, {{isdama}} was drafted by committee in a time of peace, is negotiated in a time of prosperity and with hopeful expectation, and is often closed out in a time of [[apocalypse]] when it is not just the {{isdaprov|Defaulting Party}} who is preparing to meet its maker, but the {{isdaprov|Non-Defaulting Party}} and, as like as not, those putative {{isda92prov|Reference Market-makers}} too. Lions are lying down with lambs, plagues of locusts swarm the land and risk officers’ grasp of commercial and economic fundamentals — tenuous at the best of time — disconnects from reality altogether. There was a passing nod to our old friend the [[flawed asset]] clause, though it didn’t finally come up as a topic: Lehman entered {{isda92prov|Bankruptcy}} on September 15 2008, ''entitling'' AGFP to close out, but AGFP did not do so for ten months, on 23 July 2009. In the mean time we presume it suspended its payment obligations, as it is entitled to do under Section {{isdaprov|2(a)(iii)}}. It did this not just because it was allowed to, but from its own solvency perspective, it had no choice. | ||
===“Dealer polls” are not a thing=== | ===“Dealer polls” are not a thing=== | ||
Oh, they are a ''[[legal contract]]'' thing, totally: they are just not a “this exists in the real world of derivatives trading” thing. The fact that so many legal contracts rely for their successful conclusion upon a dealer poll as a means of resolving valuationdisputes — the {{isdama}} does, as does the {{gmsla}} and the {{gmra}} — provision and no-one knows this, really only goes to show how pointless and falsely comforting is much of the [[verbiage]] that accompanies the construction and execution of modern financial instruments. | Oh, they are a ''[[legal contract]]'' thing, totally: they are just not a “this exists in the real world of derivatives trading” thing. The fact that so many legal contracts rely for their successful conclusion upon a dealer poll as a means of resolving valuationdisputes — the {{isdama}} does, as does the {{gmsla}} and the {{gmra}} — provision and no-one knows this, really only goes to show how pointless and falsely comforting is much of the [[verbiage]] that accompanies the construction and execution of modern financial instruments. | ||