Limited recourse: Difference between revisions

==[[Investment fund]]s==

'''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.

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.

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.”

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?  

The one person whose problem it should ''not'' be is the poor, weather-beaten old swap dealer. ''Yet this is what agent-pool recourse limitation does''. It transfers ''[[agent]]'' screw-up risk — perhaps a [[second-loss]] risk, but still a material risk, since you have unreasonably limited the [[first-loss]] to an arbitrary number — to the swap dealer. It is hard to understand why a swap dealer would ever agree to this. The answer likely to come: “Well, [[all our other counterparties have agreed this]].” Alas, in this particular case, the [[agent]] is probably right.

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''.

Now you might extract a [[covenant]] from your [[asset manager]] — even better, from its [[principal]] — not to precipitously whip the rug away just as things are getting jiggy — but don’t bet on it. They are likely to appeal to the [[commercial imperative]] — fair enough, the [[JC]] has a healthy respect for that — but bear in mind it is rather predicated on the [[iterated prisoner’s dilemma]] — that there will be another time, there will be more business to do; that the revenue opportunities from cooperating into the infinite & unknowable future far outweigh the value of assassinating the bird sitting in the bush this very instant. But that calculus changes, mightily, for the period between when your [[Rotary Mazda]] begins to slide sideways and when, at its current vector, it will hit that oncoming truck.

==[[Limited recourse]] formulations==