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Limited recourse: Difference between revisions
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{{a| | {{a|repack|{{image|Fidgety phillip|jpg|What happens if you do not concentrate on your debt extinction language}}}}Of a {{tag|contract}}, that a debtor’s obligations under it are limited to a defined pool of assets. You see this a lot in [[repackaging]]s, [[securitisation]]s and other structured transactions involving [[espievie]]s. [[Security]] and [[limited recourse]] are fundamental structural aspects of contracts with [[special purpose vehicle]]s and [[investment fund]]s. | ||
}}Of a {{tag|contract}}, that a debtor’s obligations under it are limited to a defined pool of assets. You see this a lot in [[repackaging]]s, [[securitisation]]s and other structured transactions involving [[espievie]]s. [[Security]] and [[limited recourse]] are fundamental structural aspects of contracts with [[ | |||
===The basic idea=== | ===The basic idea=== | ||
Investment | [[Investment fund]]s and [[Repackaging|structured note issuance vehicles]] tend to be purpose-built single corporations with no other role in life. They issue [[shares]] or [[Unit trust|unit]]s, or [[Secured, limited recourse obligation|secured note]]s, to investors and with the proceeds, buy securities, make investments and enter swaps, loans and other transactions with their counterparties. | ||
These counterparties will generally be [[Capital structure|structurally senior]] to the fund’s investors (either as unsecured [[creditor]]s, where the investors are [[Shareholder|shareholders]], or as higher-ranking [[secured creditor]]s, where the investors are also [[noteholder|secured noteholders]]). | |||
====Why?==== | |||
The main reason for limiting a [[swap dealer]]’s recourse to the [[espievie]]’s assets is ''not'' to prevent the [[swap dealer]] being paid what it is rightly owed. It is to stop an empty [[SPV]] going into formal [[bankruptcy]] ''once all its assets have been liquidated and distributed, according to their contractual [[Capital structure|priority]], to investors''. At this point, the [[espievie]] has nothing left to pay anyone, so launching a [[Bankruptcy|bankruptcy petition]] is kinda — ''academic'', but sometimes academic stuff is important if you’re a director of an [[SPV]]. | |||
Why, on the other hand, would the directors of that empty [[espievie]], bereft as it is of worldly goods, be anxious for it ''not'' to go into liquidation? Because their livelihoods depend on it: being directors of a bankrupt company opens them to allegations of reckless trading, which may bar them from acting as directors. Since that’s their day job, that’d be a bummer. | Now, why would any [[creditor]] want to put an empty [[espievie]] — one which has already handed over all its worldly goods — into liquidation? What good would it do? Search me. Why, on the other hand, would the directors of that empty [[espievie]], bereft as it is of worldly goods, be anxious for it ''not'' to go into liquidation? ''Because their personal livelihoods depend on it'': being directors of a [[bankrupt]] company opens them to allegations of reckless trading, which may bar them from acting as directors to ''other'' countries. Since that’s their day job, that’d be a bummer. | ||
But if the [[espievie]]’s bankrupt, doesn’t that mean they ''have'' been reckless? ''No''. Remember, we are in the [[parallel universe]] of [[SPV]]s. Unlike normal commercial undertakings, [[espievie]]s run on autopilot. They are designed to give exposure, exactly, to the pools of assets and liabilities they hold. That’s the deal. Everyone trades with that understanding. The directors are really nominal figures: they outsource trading decisions (if any — in a [[repackaging]], there most likely won’t be any) to an [[investment manager]]. The directors are really there to ensure accounts are prepared and a return filed each year. They are not responsible for the trading strategy that drove the [[espievie]] into the wall.<ref>The [[investment manager]] is. So should ''she'' be barred from managing assets? THIS IS NOT THE TIME OR THE PLACE TO DISCUSS.</ref> | But if the [[espievie]]’s [[bankrupt]], doesn’t that mean they ''have'' been reckless? ''No''. Remember, we are in the [[parallel universe]] of [[SPV]]s. Unlike normal commercial undertakings, [[espievie]]s run on autopilot. They are designed to give exposure, exactly, to the pools of assets and liabilities they hold. That’s the deal. Everyone trades with that understanding. ''Those'' assets might blow up, but that’s hardly the [[espievie]]’s fault. How is it supposed to know? It is a harmless little [[Open-ended investment company|otter-like creature from Guernsey]]. The directors are really nominal figures, and are also rather like otters: they outsource trading decisions (if any — in a [[repackaging]], there most likely won’t be any) to an [[investment manager]]. The directors are really there to ensure accounts are prepared and a return filed each year, and build little dams out of twigs and rushes.<ref>''That is a beaver, not an otter''. Ed.</ref> They are not responsible for the trading strategy that drove the [[espievie]] into the wall.<ref>The [[investment manager]] is. So should ''she'' be barred from managing assets? THIS IS NOT THE TIME OR THE PLACE TO DISCUSS.</ref> | ||
So all an [[investment fund]]’s [[limited recourse]] clause really needs to say is: | So all an [[investment fund]]’s [[limited recourse]] clause really needs to say is: | ||
:'' | :''Creditors’ recourse against the [[fund]] will be limited to its assets, rights and claims. Once they have been finally realised and their net proceeds applied to creditors, the fund will owe no further debt and creditors may not take any further steps against it to recover any further sum.'' | ||
But, as we shall see, sometimes [[asset manager]]s can be a malign influence, and try to further limit this. | But, as we shall see, sometimes [[asset manager]]s can be a malign influence, and try to further limit this. | ||
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==Multi-issuance [[repackaging]] vehicles: secured, limited recourse== | ==Multi-issuance [[repackaging]] vehicles: secured, limited recourse== | ||
{{Repackaging limited recourse capsule}} | {{Repackaging limited recourse capsule}} | ||
{{limited value of security in repack}} | |||
===“[[Extinction]]” versus “[[no debt due]]”?=== | |||
{{extinction vs no debt due}} | |||
==[[Investment fund]]s== | ==[[Investment fund]]s== | ||
Where you are facing an [[investment fund]] held by equity investors it is slightly — but not very — different. Generally, there is no [[Security interest|security]], since there’s no question of [[ring-fencing]] separate pools of assets. (But [[investment manager]]s can get in the way and steal options, so be on your guard — see below). | Where you are facing an [[investment fund]] held by equity investors it is slightly — but not very — different. Generally, there is no [[Security interest|security]], since there’s no question of [[ring-fencing]] separate pools of assets. (But [[investment manager]]s can get in the way and steal options, so be on your guard — see below). | ||
'''Limiting recourse to the fund’s entire pool of assets''': A provision which says “once all the fund’s assets are gone, you can’t put it into bankruptcy”, | '''Limiting recourse to the fund’s entire pool of assets''': A provision which says “once all the fund’s assets are gone, you can’t put it into bankruptcy”, ''looks'' harmless, seeing as once all the fund’s assets are gone there’s no ''point'' putting it into [[bankruptcy]]. This is the same place you would be with a single-issue [[repackaging]] vehicle: the [[corporate veil]] does the work anyway. This provision just keeps the directors of the fund in paid employment. But there’s a subtle cast on this. With no security, and no co-ordination of creditors that is typical of a structured finance deal, with security, a priority of creditors, covenants not to create any other indebtedness and so on, the ecosystem is very much mapped and controlled. In an investment fund, it isn’t. The creditors (competing brokers, prime brokers, swap counterparties, futures clearers and so on) have no idea what each is doing, and there are real benefits to them in the insolvency rules ensuring fair and equitable treatment of creditors in insolvency. The Archegos situation (which as far as I know didn’t involved limited recourse, by the way) illustrates this dynamic pretty well. | ||
==Limiting recourse to a pool managed by an [[agent]]== | ==Limiting recourse to a pool managed by an [[agent]]== | ||
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Probably because the [[principal]] has said, “I don’t trust you flash city types, with your [[Sharpe ratio]]s and your [[intelligent beta]]. If I am not careful you could put on some [[Amaranth Advisors LLC|insanely cavalier spread play on the seasonal convergence of natural gas futures]] and blow up my whole fund. I don’t want you to do that. So I am only prepared to risk the assets I give to you, and that is the end of it.” | Probably because the [[principal]] has said, “I don’t trust you flash city types, with your [[Sharpe ratio]]s and your [[intelligent beta]]. If I am not careful you could put on some [[Amaranth Advisors LLC|insanely cavalier spread play on the seasonal convergence of natural gas futures]] and blow up my whole fund. I don’t want you to do that. So I am only prepared to risk the assets I give to you, and that is the end of it.” | ||
What the [[principal]] is doing here is ''broadly'' of a piece with segregated, ring-fenced [[repackaging]]. She is saying, “swap dudes: you are trading | What the [[principal]] is doing here is ''broadly'' of a piece with segregated, ring-fenced [[repackaging]]. She is saying, “swap dudes: to stop my agent, against whom you are trading, going properly postal and blowing up my whole operation I am limiting it, and therefore ''you'', to, ''this'' bucket of assets. Cut your cloth accordingly.” | ||
And that would be fine, if it ''were'' like a ring-fenced repack. But it is not ''quite'': for one thing, poor swap dealer has no [[Security interest|security]] over the pool. It gets no “quid” for its “quo”. It is ''limited'' to that pool of assets, but it has no ''priority'' over them, as against other general creditors of the fund, as it would if it had security. It may find itself not only limited to the pool of assets but ''even then'' only recovering cents in the dollar on them. ''Double whammy''. You could fix that by having the fund represent that ''all'' other creditors are similarly limited to ''other'' pools of assets, so every creditor has its own dedicated bucket — but that is messy and unreliable. Are there really no other creditors? What about people claiming under a tort?<ref>Okay, I know, I am reaching here a bit. But still, the principle.</ref> Granting security is much cleaner and neater — but you’ll never get it. Somehow, asset managers have won this battle. Swap dealers the world over run this structural risk. One day this might come back to nip them on their bottoms, like an angry [[black swan]]. Who can say? | And that would be fine, if it ''were'' like a ring-fenced repack. But it is not ''quite'': for one thing, poor swap dealer has no [[Security interest|security]] over the pool. It gets no “quid” for its “quo”. It is ''limited'' to that pool of assets, but it has no ''priority'' over them, as against other general creditors of the fund, as it would if it had security. It may find itself not only limited to the pool of assets but ''even then'' only recovering cents in the dollar on them. ''Double whammy''. You could fix that by having the fund represent that ''all'' other creditors are similarly limited to ''other'' pools of assets, so every creditor has its own dedicated bucket — but that is messy and unreliable. Are there really no other creditors? What about people claiming under a tort?<ref>Okay, I know, I am reaching here a bit. But still, the principle.</ref> Granting security is much cleaner and neater — but you’ll never get it. Somehow, asset managers have won this battle. Swap dealers the world over run this structural risk. One day this might come back to nip them on their bottoms, like an angry [[black swan]]. Who can say? | ||
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**'''Corporate structure''': by means of a specialist corporate structure providing for segregation of the [[corporate personality]] into little cells which may<ref>such a company and [[incorporated cell company]].</ref> or may not<ref>Such a company a [[segregated portfolio company]].</ref> have their own [[legal personality]] (if the [[SPV]] is a [[segregated portfolio company]] or an [[incorporated cell company]]); | **'''Corporate structure''': by means of a specialist corporate structure providing for segregation of the [[corporate personality]] into little cells which may<ref>such a company and [[incorporated cell company]].</ref> or may not<ref>Such a company a [[segregated portfolio company]].</ref> have their own [[legal personality]] (if the [[SPV]] is a [[segregated portfolio company]] or an [[incorporated cell company]]); | ||
*'''No set-off or netting between cells''': [[Netting]] and [[set-off]] will be limited to the specific [[cell]] you are facing: this means if your deal goes down, others issued from the same [[SPV]] can continue unaffected — boo — ''and vice versa'' — hooray. | *'''No set-off or netting between cells''': [[Netting]] and [[set-off]] will be limited to the specific [[cell]] you are facing: this means if your deal goes down, others issued from the same [[SPV]] can continue unaffected — boo — ''and vice versa'' — hooray. | ||
*'''Extinction (or non-existence) of outstanding debt''': Following total exhaustion of all assets after enforcement, appropriation, liquidation and distribution, and realisation of all claims subsequently arising form those assets, your outstanding unpaid debt will be | *'''Extinction (or non-existence) of outstanding debt''': Following total exhaustion of all assets after enforcement, appropriation, liquidation and distribution, and realisation of all claims subsequently arising form those assets, your outstanding unpaid debt will be “[[Extinction|extinguished]]” — or (sigh) will [[No debt due|not be due]]. Here the intention is that you will never have legal grounds for seeking judgment, and thereafter commencing bankruptcy proceedings, for that unpaid amount once your own cell is fully unwound and its proceeds distributed. | ||
*'''A proceedings covenant''': You must solemnly promise never to set to put the [[SPV]] into [[insolvency]] proceedings. If you agree to all the foregoing, you should have concluded you have no literal right to do so, so this shouldn’t tax your conscience too greatly. | *'''A proceedings covenant''': You must solemnly promise never to set to put the [[SPV]] into [[insolvency]] proceedings. If you agree to all the foregoing, you should have concluded you have no literal right to do so, so this shouldn’t tax your conscience too greatly. | ||
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*[[Bankruptcy remoteness]] | *[[Bankruptcy remoteness]] | ||
*[[Special purpose vehicle]] | *[[Special purpose vehicle]] | ||
*[[Voidable preference]] | |||
{{ref}} | {{ref}} | ||
{{Technical Tuesday|October 20}} | |||