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Limited recourse: Difference between revisions
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You might also say that the [[principal]] — or more likely the [[agent]] — is engaged in some dissembling here. Whose problem should it be, if, in its dealings with an innocent, arm’s length counterparty trading for value and without notice of turpitude, an agent exceeds its mandate, goes [[crazy-ape bonkers]], or just, in the vernacular, ''royally fucks up''? The general principles of agency, we submit, say this is firstly the principal’s problem, and to the extent it is not the principal’s problem, it is the agent’s problem. The one person whose problem it should ''not'' be is an innocent counterparty’s. Yet this is what agent-pool recourse limitation effectively imposes. It transfers agent risk — perhaps a second-loss risk, but still a material risk, since the first loss is unreasonably limited to an arbitrary number — to the counterparty. It is really hard to understand why a principal’s swap dealer shiould agree to underwrite the risk of misperfoamcne by that principal’s agent. | You might also say that the [[principal]] — or more likely the [[agent]] — is engaged in some dissembling here. Whose problem should it be, if, in its dealings with an innocent, arm’s length counterparty trading for value and without notice of turpitude, an agent exceeds its mandate, goes [[crazy-ape bonkers]], or just, in the vernacular, ''royally fucks up''? The general principles of agency, we submit, say this is firstly the principal’s problem, and to the extent it is not the principal’s problem, it is the agent’s problem. The one person whose problem it should ''not'' be is an innocent counterparty’s. Yet this is what agent-pool recourse limitation effectively imposes. It transfers agent risk — perhaps a second-loss risk, but still a material risk, since the first loss is unreasonably limited to an arbitrary number — to the counterparty. It is really hard to understand why a principal’s swap dealer shiould agree to underwrite the risk of misperfoamcne by that principal’s agent. | ||
The answer likely to come: “Well, [[all our other counterparties have agreed this]].” Alas, in this particular case, the agent is probably right. | The answer likely to come: “Well, [[all our other counterparties have agreed this]].” Alas, in this particular case, the [[agent]] is probably right. | ||
====The asset pool is indeterminate==== | ====The asset pool is indeterminate==== | ||
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''. | 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''. | ||
====This is liability cap, not a credit mitigant=== | Now you might extract a covenant from your asset manager — even better, from your 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, in the period between the moment your porsche spyder begins to slide sideways and the point where at its current vector, it will hit the oncoming truck. | ||
Thirdly, and most critically: This is a | |||
====This is liability cap, not a credit mitigant==== | |||
Thirdly, and most critically: This is a limitation on the value of your claim against a counterparty who does have available assets. You are leaving money on the table. This is a ''trading'' decision, not a ''credit'' decision. It is as if you have sold your counterparty a put option, limiting its exposure under your contract. Ask yourself why your [[credit]] team, rather than [[trading]], are being asked to approve this. Ask yourself, too, how trading might feel, if the counterparty should fail whilst [[out of the money]] when you are perfectly delta-hedged, and the | |||
===[[Limited recourse]] formulations=== | ===[[Limited recourse]] formulations=== | ||