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Lehman Brothers International (Europe) v AG Financial Products, Inc.: Difference between revisions

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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.
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''.
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''.
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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:
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. }}
{{q|When this trial first started, the court was skeptical about how, given such a large discrepancy, [AGFP]’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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===“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.
===The Loss method===
Rather than seeking dealer quotations, AGFP ran scenario analyses for defaults on the portfolios of mortgages it was insuring if they were allowed to run to term (which is when its obligation to pay any losses on the portfolio to insured tranches would come due).  This was an audited, checked process and the court found it plausible and consistent with what you would expect an insurer to do. </ref>It wasn’t mentioned, in the judgment, but by the time the trial rolled around the CDOs would have long since matured so you would think they would know the ''exact'' default levels — but still.</ref>


LBIE’s rebuttal evidence, which rejected these actuarial methods and corroborating views in favour of projections obtained from other banks, the court felt, was a load of self-serving hooey. This is not a quote; just a general impression. “Suspect”, “quite dubious”, “not objective”, “had every incentive to make the outlook for the Transactions seem as dire as possible in order to set the stage to collect more from their monoline insurers” — these ''are'' direct quotes.
{{quote|
Thus, under the ISDA Master Agreement, the non-defaulting party “need not” consider market prices, especially where to do so would render the Termination amount “commercially unreasonable.” By limiting the use of market prices, ISDA thereby contemplates a situation, like the one here, where market prices are completely divorced from value. In addition, ISDA’s “{{isda92prov|Loss}}” provision is flexible enough to take into account all types of “loss of bargain,” even Assured’s, which had nothing to do with market prices.  <br>
Where reference to market prices does not always lead to a [[commercially reasonable]] result, courts favor a valuation that does not use market prices. ... <br>
Market prices leading to a commercially unreasonable valuation ''is especially likely during periods of severe market disruption'' where reliable market prices may not exist.}}
The court didn’t believe the bank’s valuations.
{{Dealer polls after LBIE v AGFP}}
{{Dealer polls after LBIE v AGFP}}
{{sa}}
{{sa}}
*[https://www.nycourts.gov/reporter//pdfs/2023/2023_30692.pdf Judgment]
*[https://www.nycourts.gov/reporter//pdfs/2023/2023_30692.pdf Judgment]
{{ref}}
{{ref}}
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