Dispute Collateral Call
After the margin call notice has been sent, the counterparty will generally want to confirm its agreement to the margin call. There are three options for responding to a margin call:
- full agreement,
- partial agreement (where, for example, a party agrees to five million of a ten million call), and
- full dispute (where there is no agreement to the other party’s call or indeed a counter call, for example, if both parties call for ten million, that gives a twenty million dispute).
If there is agreement on the terms of the margin call, for a full agreement or the undisputed amount of a partial agreement, the parties will agree the specific collateral types and amounts to be transferred in order to satisfy the margin call, as well as confirming the timing of those movements. Collateral movements are monitored to ensure the successful delivery of assets and, when received, collateral holding records are updated. If the counterparty disagrees with the margin call, it may dispute the call and the dispute resolution process described below will then begin. (1)
In the event of a dispute (of the types identified above), the processes described below are
currently carried out.
Some level of investigation of the dispute will be carried out immediately. Depending on the size and complexity of a portfolio, this may be done by the margin manager generating the disputed margin call or may be handed over to a dedicated portfolio reconciliation or dispute resolution team. Although the level of investigation may differ, some of the areas that are usually examined for obvious discrepancies are:
- differences in trade population;
- threshold differences;
- collateral asset differences;
- significant differences in valuations of specific trades; and
- independent amount differences.
If the parties are still unable to agree upon the valuations of certain trades or other aspects of the collateral calculation, the dispute resolution mechanism outlined in the applicable collateral agreement will become effective.
In the event a margin call is disputed, the parties will initially have their collateral operations functions liaise with each other to determine the cause of a dispute. The method of resolving disputes can vary, depending on the type of dispute, the size of portfolio, the sophistication of dispute resolution or portfolio reconciliation technology (i.e. comparison of trade files with mark-to-market) technology and frequency with which the portfolio reconciliation is performed. (2)
Credit Support Documents Process
The process of resolving a collateral dispute will follow a sequence of events and will pass through a number of different functions within an organization. At all points of a dispute, it is best practice to ensure communication between collateral operations and appropriate control and risk functions (product controllers and credit risk control) is maintained. The below process represents market practice rather than documentary requirement: (3)
- Step 1 – Exchange of portfolios and determine the type of dispute (see below)
- Step 2 – Perform a reconciliation (see below)
- Step 3 – Resolving the dispute (see below)
Exchange of portfolios and determine the type of dispute and Perform a reconciliation
After the agreement to settle any undisputed amount, the immediate next step would be for parties to exchange margin call calculations and portfolio details. Initially, high-level comparisons will be performed on aggregate values to identify whether the dispute is driven by exposure (MTM or portfolio composition), collateral value (position, pricing or haircut differences), Independent Amount, or call calculations.
Depending on the type of dispute, parties will target their reconciliation to determine actual positions or calculations driving a dispute. This process can vary in duration and complexity when taking into account the size of a portfolio and the sophistication of reconciliation and dispute resolution processes and technology. Some organizations have dedicated dispute resolution and portfolio reconciliation functions who perform this process and utilize third party vendor services and applications to undertake frequent automated two way reconciliations. These can considerably reduce both the effort and time to identify the
cause of the dispute.
(There is a risk of) an unequal playing field, in that it is likely that larger firms, due to their size and greater degree of regulatory scrutiny, are perhaps more likely to have robust procedures in place than other entity types. (4)
Resolving the dispute
The types of dispute are categorized in order of complexity below. Parties will typically prioritize the resolution disputes depending on size and counterparty risk. In addition, within a large portfolio, multiple transactions may positively contribute to a dispute and these will generally be prioritized by size:
- Capable of remedy through contractual evidence. The most immediately resolvable type of dispute tends to be where some form of clear and binding evidence such as a confirmation or a credit support document will determine the outcome of a disputed call. These disputes are generally caused by booking and system timing differences and/or reference data irregularities. Once identified, they result in either party adjusting their calculations and reducing or eliminating the disputed amount.
- Capable of remedy through market or empirical evidence, resolved through internal reassessment, correction or negotiation. The value of a trade is typically derived by independently developed proprietary pricing models along with market observations. The mid-market value that firms collateralize from will generally be a function of the bid/offer spread that each respective firm would expect to transact at in the market. This may differ from party to party, based on a number of factors, including divergence in models and illiquid markets. As a result, parties may apply certain tolerances (acceptable differences) depending on the bid/offer spread of the particular contract or instrument and, depending on their prudent risk management policies, may decide not to pursue a dispute. (5)
- Capable of remedy through documented formal and legally binding dispute resolution.
If parties cannot come to an agreement, the dispute resolution mechanism outlined in the
relevant Credit Support Document will become effective. These are bilaterally negotiated terms, but will typically follow a course of seeking a number of market quotations for the positions in dispute from other market participants. If quotations can be located, an average of these quotations will be applied to the subject transaction and collateral moved appropriately. There are some situations where a market quotation cannot be obtained, then the Valuation Agent, defined in the Credit Support Document, will determine the value for that day only. The process resets the following business day. (6)
The Dispute Resolution Procedure is intended to:
- ensure transparency and engagement in resolving disputes;
- demonstrate market-makers acting as market-makers, committing to providing firm executable prices to be used in the resolution of disputes; and
- establish a clear hierarchy of prices, ensuring that firm executable prices supersede indicative quotes for dispute resolution. (7)
- Market Review of OTC Derivative Bilateral Collateralization Practices. International Swaps and Derivatives Association – March 1, 2010
- Along with performing a verification of mark to market values, product controllers and risk
management generally perform this process or set this guidance. If a party’s calculation is deemed to be erroneous by its controllers, it should be corrected, contributing to a resolution of the collateral dispute. In the event that both parties deem their calculations appropriate, bilateral discussions would commence between the parties’ controllers and trading desks in order to reach an agreement that may result in one or both parties
adjusting their mark to market calculations, agreeing an acceptable difference, as referred to above, or some other bilaterally agreed remedial action.
- Financial Risk
- Collateral Asset
- Credit Support
- Credit Risk
- Prime Brokerage
- Alternative Dispute Resolution
- Trade Dispute
- Online Dispute Resolution
- Labour Dispute
- Collective Dispute
- Industrial Dispute