Template:M gen Equity Derivatives Calculation Agent, Determining Party and Hedging Party

Why “Agent” here, and “Party” there?

Calculation Agent; There is a sense that an “agent” is one who acts on the behalf of others — both counterparties, in the case of a derivative contract — and should not consider its own interests. The Calculation Agent in any swap will generally be one of the counterparties — most usually the swap dealer — and in equity derivatives definitely so. The “agent” tag is meant to remind us that when acting as Calculation Agent one acts by reference to the distilled abstract qualities of the market, meditating on the golden mean, as it were, and not by reference to one’s own sordid axes and grubby financial interests.

All the same we dimly apprehend that a Calculation Agent who also happens to be one of the counterparties has some kind of conflict of interest — buy-side legal eagles definitely apprehend that — but in equity derivatives the conflict is more one of form than substance: the swap dealer hedges itself delta-one and has nothing to gain, in the abstract, by valuing a Transaction artifically high or low. Its revenue, remember, comes from its commissions and its financing efficiency, not through the price of the underlier.

Hedging Party and Determining Party: The Determining Party and Hedging Party are, by contrast, parties (not necessarily counterparties to the actual Transaction, though usually) overtly acting with regard to their own position, being the hedge transaction, not the equity swap itself — though in every case, required to do so in good faith and using commercially reasonable procedures.

“Good faith and commercial reasonableness” standard

At first blush it looks like only the Calculation Agent is subject to the “in good faith and a commercially reasonable manner” standard, but this is really just the way ISDA’s crack drafting squad™ decided to express themselves. Whereas the performance standard is baked into the definition of Calculation Agent in Section 1.40, for Determining Party it is set out separately in Section 12.8(b), and 12.8(e) and 12.8(g): “Any Cancellation Amount will be determined by the Determining Party (or its agent), which will act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result.”

Likewise for the Hedging Party, which Section 12.9(a)(v) requires to have made commercially reasonable efforts to hedge before declaring there has been a Hedging Disruption, as does Section 12.9(a)(vii) for Loss of Stock Borrow and Section 12.9(a)(xi) when sourcing a Lending Party.