Template:M gen Equity Derivatives 12.8(f)

A dispute right for Calculation Agent and Determining Party determinations?

Recognising that “should you?”, and “will you have to?”, are different questions — buyside counsel may insist, using their regular platter of exotic preparations of canard that buyside lawyers always serve up, and you may ultimately decided not to die in a ditch about it, however much it pains you — recognising all that; here — if you are doing synthetic prime brokerage business — is how it rolls.

Client’s lawyer: we must have a dispute right, so help me.

• The Dealer will be the Calculation Agent. (True.)
• The Dealer will be the Hedging Party. (True.)
• The Dealer will be the Determining Party. (True.)
• Dealers are bad, venal people. They have blackened hearts and will stop at nothing to rip their clients’ faces off. We need some check on their unfettered and sure-to-be outrageously exercised discretion. (A matter of debate and, to be sure, recent history has not looked kindly on the goings on in some dealers, but if that’s your starting point a far better question is “why are you doing business with such a rascal in the first place”? And generally, hedge funds haven’t had a spotless track record either, have they? For every Lehman, there’s been an LTCM, Amaranth, Archegos, SAC, Galleon and, er, Madoff.)

The Dealer’s lawyer: Look, dudes, you seem to be missing the point.

• Firstly, This is synthetic prime brokerage. It isn’t an arm’s length trading arrangement. It is business facilitation for you. When we hedge, we are delta neutral. That means if our hedge pays us 50, we pay you 50. So firstly, we can’t rip your face off, even though it is one only a mother could love.
• Secondly, we are owe you best execution
• Thirdly, because we delta hedge, we come up with our “determinations” by actually selling the right number of shares. It isn’t like we confect some hypothetical valuation based on a model some geek in correlation trading built in excel. We don’t go ask some stooge dealers for a soft estimate, and promise them champagne in the mail. We actually sell the stock. Our own money out the door. We can’t get it back. What you are asking is to second guess our actual transaction by you asking some stooge dealer for a soft estimate. This is like putting a bet on Crystal Palace to beat Scunthorpe and when Palace loses, telling the bookmaker: “but my buddy is a football expert, and he says Palace were dead unlucky, hit the crossbar a couple of times, and that Scunthorpe goal should have been disallowed, so really it should have been a 4:0 win to Palace. So you have to pay me anyway.”
• Fourthly, there are a ton of controls on us already, contractual, regulatory and economic:
  • Contractual: Section 12.8 of the Equity Derivatives (especially Sections 12.8(b) and 12.8(g)) is shot through with requirements to act in a commercially reasonable manner, using commercially reasonable procedures, going out to leading dealers and so on. Likewise, a whenever a Calculation Agent is acts or exercises judgment in any way, it must do so in good faith and in a commercially reasonable manner (See Section 1.40). What the dispute provision is aimed to do, your adversary will say, is provide a stick to enforce that obligation. but at some point this becomes an infinite regression: what if the dispute is not registered in good faith? Where is the stick to enforce that?
  • Regulatory: There's the best execution obligation. The COBS rules require us to treat our clients fairly.
  • Economic: You are the client. You can pull your business. You can decide to never give us another trade. Seeing as we are delta-one hedged, we have no incentive at all to lowball, and every incentive to give you the best price we can manage.