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Limited recourse: Difference between revisions
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Over the years the secured, limited recourse technology has been refined and standardised, and now plays little part in the education of a modern-day structured finance lawyer, though, at his mother’s knee, he might once have been told fairy stories about what became of poor Fidgety Phillip when he carelessly put “extinction” rather than “no debt due” in a pricing supplement on his way home from school and burned to death.<ref>Come to think of it he may have forgotten to file a [[Slavenburg]].</ref> | Over the years the secured, limited recourse technology has been refined and standardised, and now plays little part in the education of a modern-day structured finance lawyer, though, at his mother’s knee, he might once have been told fairy stories about what became of poor Fidgety Phillip when he carelessly put “extinction” rather than “no debt due” in a pricing supplement on his way home from school and burned to death.<ref>Come to think of it he may have forgotten to file a [[Slavenburg]].</ref> | ||
===General limited recourse for investment | ===General limited recourse for [[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, since there’s no question of [[ring-fencing]] separate pools of assets. (But investment managers 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, since there’s no question of [[ring-fencing]] separate pools of assets. (But investment managers 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”, is essentially 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. | '''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”, is essentially 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. | ||
=== | ===Limiting recourse to assets managed by an [[agent]]=== | ||
On the other hand, limiting recourse to a pool of assets ''within'' a single [[Legal entity|fund entity]] — say to those managed by a single [[investment manager]] (some funds subcontract out the management of their portfolios to multiple asset managers) — being a ''subset'' of the total number of assets owned by the fund — is a different story altogether. This, by sleepy market convention, has become a standard part of the furniture, but to the [[JC]] and his friends and relations, seems ''batshit insane''. | |||
So firstly, the investment manager is an [[agent]]. An [[agent]] isn’t liable ''at all'' for ''any'' of its [[principal]]s’ obligations. It is a mere [[intermediary]]: the [[JC]] have waxed long and hard enough about that elsewhere; suffice to say the concept of [[agency]] is one of those things we feel [[Legal concepts all bankers should know|''everyone'' in financial services should know]]; this is not one to drop-kick to your [[legal eagle]]s: it is fundamental to the workings of all finance. | ====The manager is an agent==== | ||
So firstly, the [[investment manager]] is an [[agent]]. An [[agent]] isn’t liable ''at all'' for ''any'' of its [[principal]]s’ obligations. It is a mere [[intermediary]]: the [[JC]] have waxed long and hard enough about that elsewhere; suffice to say the concept of [[agency]] is one of those things we feel [[Legal concepts all bankers should know|''everyone'' in financial services should know]]; this is not one to drop-kick to your [[legal eagle]]s: it is fundamental to the workings of all finance. | |||
So why would an agent seek to limit its principal’s liability to the particular pool of assets that principal has allocated to that agent? | So why would an agent seek to limit its principal’s liability to the particular pool of assets that principal has allocated to that agent? Probably because the principal has said, I don’t trust you flash fund manager 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. 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]]. “Swap dudes: you are trading against, and limited in recourse to, this bucket of assets. Cut your cloth accordingly.” But not ''quite'': for one thing, poor swap counterparty has no security over the pool, and so gets no “quid” for its generously afforded “quo”. The swap counterparty may be limited to that pool of assets, but it has no priority over them as against other general creditors of the fund: should (heaven forfend) the fund blow up our intrepid swap dealer 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, but that is messy and unreliable. Security is much cleaner and neater, but you’ll never get it. | |||
Secondly, a pool of assets [[for the time being]] allocated to an investment manager is ''kind of nebulous''. What the client giveth, the client can taketh away. If the client’s [[asset manager]] has gone rogue, that is ''exactly'' the time at which it will be anxiously raking its assets back. So the [[swap dealer]] facing that pool of assets — who has been faithfully handling and executing all orders competently and in good faith, of course — may find that nice big juicy bucket of assets to which it has limited its recourse, ''suddenly has a hole in it''. | |||
===[[Limited recourse]] formulations=== | ===[[Limited recourse]] formulations=== | ||