Template:Flawed asset capsule: Difference between revisions

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 The “[[The bilaterality, or not, of the ISDA|bilaterality]]” of most derivatives arrangements means that either party may, net, be “[[out of the money]]” — that is, across all outstanding transactions, it would have to ''pay'' a net sum of money if all transactions were terminated. This is a notional debt that only becomes “due” as such if you designate an {{{{{1}}}|Early Termination Date}} under the Master Agreement. So an [[out-of-the-money]] {{{{{1}}}|Non-defaulting Party}} has a good reason therefore ''not'' to close out the ISDA. Why should it have to pay out just because a {{{{{1}}}|Defaulting Party}} has failed to perform its end of the bargain? On the other hand, if it forebears from terminating against a bankrupt counterparty the {{{{{1}}}|Non-defaulting Party}} doesn’t want to have to continue stoically paying good money away to a bankrupt counterparty who isn’t reciprocating.
-An [[out-of-the-money]] {{{{{1}}}|Non-defaulting Party}} seems, therefore, to be in a bit of a cleft stick.
+An [[out-of-the-money]], {{{{{1}}}|Non-defaulting Party}} seems to be, therefore, in a bit of a cleft stick.
-Section 2(a)(iii) allows the {{{{{1}}}|Non-defaulting Party}} the best of both worlds. The [[conditions precedent]] to payment not being satisfied it can just stop performing, and sit on its hands, and thereby not thereby crystallising the [[mark-to-market]] loss implied by its [[out-of-the-money]] position. The {{{{{1}}}|Defaulting Party}}’s “asset” – its right to be paid, or delivered to under the {{{{{1}}}|Transaction}} – is “flawed” in the sense that its rights don’t apply for so long as ''the [[conditions precedent]] to payment are not fulfilled''.
+Section {{{{{1}}}|2(a)(iii)}} allows the {{{{{1}}}|Non-defaulting Party}} the best of both worlds. The [[conditions precedent]] to payment not being satisfied, it can just stop performing, and sit on its hands and thereby not thereby crystallise the [[mark-to-market]] loss implied by its [[out-of-the-money]] position.
+The {{{{{1}}}|Defaulting Party}}’s “asset” — its right to be paid, or delivered to under the {{{{{1}}}|Transaction}} — is “flawed” in the sense that its rights don’t apply for so long as ''the [[conditions precedent]] to payment are not fulfilled''.
 Conceivably you ''could'' invoke a flawed asset provision even if you were [[in-the-money]], but you would be mad to.
-=====Which events?=====
+====Which events?====
-Exactly ''which'' default events can trigger a flawed asset clause will depend on the contract. Under the {{isdama}} it {{{{{1}}}|Events of Default}} and even {{{{{1}}}|Potential Events of Default}} do, but {{{{{1}}}|Termination Event}}s and {{{{{1}}}|Additional Termination Event}}s do not. {{{{{1}}}|Termination Event}}s are softer, “hey look, it’s no-one’s fault, it’s just one of those things” kind of close outs, so that makes some sense — but on the other hand this is not really true of {{{{{1}}}|Additional Termination Event}}s, which tend to be credit-driven and with more “culpability” and “event-of-defaulty-ness” about them. This is, a bit dissonant, but there are far greater dissonances, so we park this one and carry on.
+Exactly ''which'' default events can trigger a flawed asset clause will depend on the contract. Under the ISDA, {{{{{1}}}|Events of Default}} and even ''Potential'' {{{{{1}}}|Events of Default}} do, but {{{{{1}}}|Termination Event}}s and {{{{{1}}}|Additional Termination Event}}s do not.
+This is because most Termination Events are softer, “hey look, it’s no-one’s fault, it’s just one of those things” kind of closeouts — but this is not really true of {{{{{1}}}|Additional Termination Event}}s, which tend to be credit-driven and girded with more “culpability” and “event-of-defaulty-ness”.
+This is, a bit dissonant, but there are far greater dissonances, so we park this one and carry on.
+====2(a)(iii) in a time of Credit Support====
+Flawed assets entered the argot in a simpler, more (''less''?) peaceable time when two-way, zero-threshold, daily-margined collateral arrangements were an unusual sight. Nor, in those times, were dealers often of the view that they might be on the wrong end of a flawed assets clause. They presumed if anyone was going bust, it would be their client. Because — the house always wins, right? The events of [[Global financial crisis|September 2018]] were, therefore, quite the chastening experience.
-=====2(a)(iii) in a time of Credit Support=====
+In any case without collateral, a {{{{{1}}}|Non-defaulting Party}} could, be nursing a large, unfunded [[mark-to-market]] liability which it would not want to pay out just because the clot at the other end of the contract had driven his fund into a ditch.
-Flawed assets entered the argot in a simpler, more (''less''?) peaceable time when two-way, zero-threshold, daily-margined collateral arrangements were a fantastical sight. It was therefore reasonably likely that a {{{{{1}}}|Non-defaulting Party}} might be nursing a large unfunded [[mark-to-market]] liability which it would not want to have to pay out on just because the clot at the other end of the contract had driven his fund into a ditch. A large uncollateralised position is a less likely scenario in these days of mandatory [[regulatory margin]] in which counterparties generally cash-collateralise their net market positions to, or near, zero each day.
-Nor, we think, did it occur to dealers, who typically insisted on the flawed assets clause, that they might be on the wrong end of it. The events of [[Global financial crisis|September 2018]] were, therefore, quite the chastening experience.
+That was then: in these days of mandatory [[regulatory margin]], counterparties generally cash-collateralise their net market positions to, or near, zero each day, so a large uncollateralised position is a much less likely scenario. So most people will be happy enough just closing out: the optionality not to is not very valuable.