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Template:Flawed asset capsule: Difference between revisions
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Following an [[ | Following certain default events,<ref>Exactly ''which'' defaults will depend on the contract: under an {{isdama}} it will include {{{{{1}}}|Events of Default}} and {{{{{1}}}|Potential Events of Default}}, but not {{{{{1}}}|Termination Events}} or {{{{{1}}}|Additional Termination Events}} — which, given the “culpability” of [[ATE]]s, is something of a dissonance in itself.</ref> a “[[flawed asset]]” provision allows an innocent, but [[out-of-the-money]] counterparty to a {{tag|derivative}} or {{tag|securities finance}} transaction to suspend performance of its obligations ''without'' terminating the transaction and thereby crystallising a [[mark-to-market]] loss implied by its out-of-the-money position. | ||
The defaulting party’s asset – its right to be paid, or delivered to under the transaction – is “flawed” in the sense that it doesn’t apply for so long as ''the [[conditions precedent]] to payment are not fulfilled''. | The defaulting party’s asset – its right to be paid, or delivered to under the transaction – is “flawed” in the sense that it doesn’t apply for so long as ''the [[conditions precedent]] to payment are not fulfilled''. | ||
The most famous flawed asset clause is Section {{ | The most famous flawed asset clause is Section {{{{{1}}}|2(a)(iii)}} of the {{isdama}}. It entered the argot in a simpler, more peaceable time, when two-way, zero-threshold, daily margined {{tag|CSA}}s were a rather fantastical sight, and it was reasonably likely that a counterparty might be nursing a large unfunded mark-to-market liability which it would not want to have to fund just because the clot at the other end of the contract had gone belly-up. Closing out the contract would crystallise that liability, so the flawed asset provision allowed that innocent fellow to just stop performing the contract altogether, rather than paying out its [[mark-to-market]] loss. | ||
That was then; 1987; they hadn’t even invented the {{csa}}. Even once they had, it would be common for a muscular [[broker/dealer]]s to insist on one-way margining: “You, no-name pipsqueak highly [[Leverage|levered]] [[hedge fund]] type, are paying ''me'' [[variation margin]] and [[initial margin]]; I, highly-capitalised, prudentially regulated<s>, [[Balance sheet|balance-sheet]] [[Leverage|levered]]</s><ref>Amazing in hindsight, really, isn’t it.</ref> financial institution, am not paying ''you'' ''any'' [[margin]].” | That was then; 1987; they hadn’t even invented the {{csa}}. Even once they had, it would be common for a muscular [[broker/dealer]]s to insist on one-way margining: “You, no-name pipsqueak highly [[Leverage|levered]] [[hedge fund]] type, are paying ''me'' [[variation margin]] and [[initial margin]]; I, highly-capitalised, prudentially regulated<s>, [[Balance sheet|balance-sheet]] [[Leverage|levered]]</s><ref>Amazing in hindsight, really, isn’t it.</ref> financial institution, am not paying ''you'' ''any'' [[margin]].” | ||
Well, those days are gone, and bilateral zero-threshold margin arrangements are more or less obligatory nowadays, so it’s hard to see the justification for a [[flawed asset]] provision. But we still have one, and modish post-crisis threats by regulators worldwide to stamp them out seem, some time in 2014, to have come to a juddering halt. | Well, those days are gone, and bilateral zero-threshold margin arrangements are more or less obligatory nowadays, so it’s hard to see the justification for a [[flawed asset]] provision. But we still have one, and modish post-crisis threats by regulators worldwide to stamp them out seem, some time in 2014, to have come to a juddering halt. | ||
One can level many criticisms at the flawed assets concept these days, and the [[JC]] does. Not only is it often triggered by vague, indeterminate things, there are many cases where its technical application makes absolutely no sense. Really, if a counterparty doesn’t like the position it is in when a counterparty defaults, its remedy is simple. Close out. Just saying “talk to the hand” really ought not do in these enlightened, margined times. | |||