Template:M summ Equity Derivatives 12.7: Difference between revisions

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===Section {{eqderivprov|12.7(c)}} and the curious question of the multiple {{eqderivprov|Determination Agent}}s===
The calculation of {{eqderivprov|Cancellation Amount}}s following {{eqderivprov|Extraordinary Event}}s is one of those classic [[negotiation oubliette]]s that opposing counsel will gladly fall into, the way Unlucky Alf falls into open manholes. The [[JC]] has seen storied partners of [[Magic circle law firm|serious law firms]] get in quite the lather about this, from positions of apparent ignorance, hotly insisting [[co-calculation agent|co-caclulation agency]] to be a matter of life or death, predicated on the assumption that given half a chance, these venal [[swap dealer]]s won’t break a stride before ripping hunks off their customers’ faces.
Now, here is a funny thing.


In its ever-unquenched thirst to cater for every conceivable eventuality, however inconceivable, the ’squad devoted themselves in Section {{eqderivprov|12.7(c)}}(ii) to the contingency that there might be ''two'' {{eqderivprov|Determining Parties}} appointed to hash out the {{eqderivprov|Cancellation Amount}} that applies for a {{eqderivprov|Transaction}}. This, we think, is intended to imagine some kind of [[co-calcuklation agent]] regime where the parties make independent calculations and split the difference.
They will say, “my customer must have the right to challenge your price. It must be allowed to consult its favourite [[dealer]], and ask ''it'' what the {{eqderivprov|Cancellation Amount}} should be. We must have a [[dealer poll]]. Something like that. Take the average. You know.”


Unfortunately, having had the energy to contemplate this vanishingly remote scenario, our ninjarey friends didn’t have anything left to write the clause properly, and as a result what it tells the co-{{eqderivprov|Determining Parties}} to do doesn’t make any sense. In fairness, simply ''having'' co-{{eqderivprov|Determining Parties}} doesn’t make any sense, but that won’t do: if you insist on contemplating something stupid, you should at least work it through properly, so stupid parties who fall into the trap of selecting the option don’t get themselves into bother later, which we regret to say they will do if they select two {{eqderivprov|Determining Parties}}.
This is a wonderful [[narrative]], vouchsafing as it does [[tedious]], remunerative arguments that their customers may indeed believe save them from great peril — but it really need not be that complicated.


But first things first.
Firstly: remember the [[commercial imperative]]. As the old saying has it, “he who burns his customer’s shed down, steals his oxen and sells his children into slavery cannot expect to sit at his customer’s annual broker review without the subject coming up”.


====Why it makes no sense to have two {{eqderivprov|Determining Parties}}====
Secondly, ask why, if your customer’s other broker is so damn good, it didn’t get the trade in the first place?
Cast your mind back to the reason we have a {{eqderivprov|Determining Party}} in the first place:


{{quote|''...determination of a {{eqderivprov|Cancellation Amount}} is inextricably related to the [[hedge]] and — especially where there is a [[Additional Disruption Event - Equity Derivatives Provision|disrupted market]] – this is best to be calculated by the one whose problem it is to unwind that hedge: namely, the {{eqderivprov|Hedging Party}}. In theory (though ''almost'' never in practice) the {{eqderivprov|Hedging Party}} might not be the {{eqderivprov|Calculation Agent}}.''<ref>Yes, that ''is'' the JC quoting itself. Bite me — if you can’t be bothered seeing what else you can find on this topic on the Google, that is.</ref>}}
Thirdly, remember what is going on here: the [[dealer]] — who the customer selected precisely ''because'' it is such a good broker, with unbeatable access to [[liquidity]], flawless execution and competitive pricing, right? (and if not, ''why'' not?) — is struggling to find a good price for a stock because it has been de-listed, nationalised, gone insolvent, or been subject to some awful liquidity crunch. Your dealer, not having a dog in the fight, will want to get the best price it can to terminate the hedge as it will pass that on to its customer.


Now, remember what is going on here. We have a client, going long or short some Equity underlier without actually having to buy it, and a [[swap dealer]], providing that exposure. The swap dealer has no skin in the game: it will be hedging delta-one, usually by buying (or short-selling) the underlier outright. It has no particular interest in the prince of the share, as long as it can pass it on to its client.  
Extraordinary Events being, well, extraordinary, this will not happen often, and no dealer with a functioning brain<ref>I know, I know.</ref> will just terminate a position against its customer’s wishes without consulting its customer. It will say, “look, here’s the price we see: does this work for you?”  If the customer can source a better price — as in, “firm, tradable price” then the dealer will happily take it. But honestly it isn’t that likely: all the customer can really do is ask another broker, who is likely to see a similar picture. Colour me wrong on that, but if so, happy days: as long as our Determining Party can lift the offer, it will take it and everyone will be ''simpatico''. But, still, it is unlikely.  


If the {{eqderivprov|Transaction}} has been disrupted so badly it is to be cancelled, this means is hard to get a price in the underlier, That, in turn, means it is hard to liquidate the hedge. Whose problem is that? The {{eqderivprov|Hedging Party}}’s. To be clear this is no idle intellectual speculation: there is no looking at some fantastical model dreamt up by the most delusional quant on the trading floor to derive some mad price that will ruin the client for nothing. ''No''. The {{eqderivprov|Hedging Party}} ''is actually long the risk''. It will pay out of its own pocket to get out of that risk. The amount it pays away is exactly what it will expect its client to suffer. That is the deal.
And in the mean time, while the customer is going through its agonised machinations — should I? shouldn’t I? — the price that its dealer ''did'' get can go quickly stale. Once it’s off the table, the customer loses its right to trade at that price. There needs to be this tension: dealers are not writing options here: the customer only gets a price the dealer can actually trade on.


The Hedging Party will, therefore, be ''most'' unamused if the client asks it to countenance some alternative price someone ''else'' has come up with to value its own hedge liquidation. It will, tersely, say, “Look, I know you have a great relationship with [[Wickliffe Hampton]] and everything, but I could not care a row of buttons where it sees the value of my hedge, frankly, unless it is prepared to by my actual hedge, from me, in which case let’s go.”
Accordingly, the dealer will be ''most'' unamused if a customer asks it to consider an alternative price someone ''else'' has come up with to value its own hedge liquidation. This is like saying, to a football fan, “look, I know Crystal Palace lost to Scunthorpe in extra time at the weekend, but my mate 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 called off-side, so why don’t we call this 4:0 to Palace?”


At the point where [[Wickliffe Hampton]] does that, it is agreeing with the Hedging Party on its valuation and does not, Q.E.D. need to be co-determining party.
So when a customer huffily expects a right to provide a second opinion that is ''not'' a tradable price, it — and its lawyers — can expect a rather plainly spoken response. To the complaint that, “but the stock has been delisted! There is no price in the market! I can’t be sure this price is right!”  comes the answer: friend: that is ''exactly'' the risk you ran when you bought a swap on this stock. You are buying ''precisely'' the risk that it goes insolvent, gets nationalized or is delisted.
 
====Why, if you ''must'' insist on having two {{eqderivprov|Determining Parties}}, this clause doesn’t work====

Latest revision as of 12:25, 21 January 2022

The calculation of Cancellation Amounts following Extraordinary Events is one of those classic negotiation oubliettes that opposing counsel will gladly fall into, the way Unlucky Alf falls into open manholes. The JC has seen storied partners of serious law firms get in quite the lather about this, from positions of apparent ignorance, hotly insisting co-caclulation agency to be a matter of life or death, predicated on the assumption that given half a chance, these venal swap dealers won’t break a stride before ripping hunks off their customers’ faces.

They will say, “my customer must have the right to challenge your price. It must be allowed to consult its favourite dealer, and ask it what the Cancellation Amount should be. We must have a dealer poll. Something like that. Take the average. You know.”

This is a wonderful narrative, vouchsafing as it does tedious, remunerative arguments that their customers may indeed believe save them from great peril — but it really need not be that complicated.

Firstly: remember the commercial imperative. As the old saying has it, “he who burns his customer’s shed down, steals his oxen and sells his children into slavery cannot expect to sit at his customer’s annual broker review without the subject coming up”.

Secondly, ask why, if your customer’s other broker is so damn good, it didn’t get the trade in the first place?

Thirdly, remember what is going on here: the dealer — who the customer selected precisely because it is such a good broker, with unbeatable access to liquidity, flawless execution and competitive pricing, right? (and if not, why not?) — is struggling to find a good price for a stock because it has been de-listed, nationalised, gone insolvent, or been subject to some awful liquidity crunch. Your dealer, not having a dog in the fight, will want to get the best price it can to terminate the hedge as it will pass that on to its customer.

Extraordinary Events being, well, extraordinary, this will not happen often, and no dealer with a functioning brain[1] will just terminate a position against its customer’s wishes without consulting its customer. It will say, “look, here’s the price we see: does this work for you?” If the customer can source a better price — as in, “firm, tradable price” then the dealer will happily take it. But honestly it isn’t that likely: all the customer can really do is ask another broker, who is likely to see a similar picture. Colour me wrong on that, but if so, happy days: as long as our Determining Party can lift the offer, it will take it and everyone will be simpatico. But, still, it is unlikely.

And in the mean time, while the customer is going through its agonised machinations — should I? shouldn’t I? — the price that its dealer did get can go quickly stale. Once it’s off the table, the customer loses its right to trade at that price. There needs to be this tension: dealers are not writing options here: the customer only gets a price the dealer can actually trade on.

Accordingly, the dealer will be most unamused if a customer asks it to consider an alternative price someone else has come up with to value its own hedge liquidation. This is like saying, to a football fan, “look, I know Crystal Palace lost to Scunthorpe in extra time at the weekend, but my mate 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 called off-side, so why don’t we call this 4:0 to Palace?”

So when a customer huffily expects a right to provide a second opinion that is not a tradable price, it — and its lawyers — can expect a rather plainly spoken response. To the complaint that, “but the stock has been delisted! There is no price in the market! I can’t be sure this price is right!” comes the answer: friend: that is exactly the risk you ran when you bought a swap on this stock. You are buying precisely the risk that it goes insolvent, gets nationalized or is delisted.

  1. ↑ I know, I know.
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