Forward Transaction
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In the context of a GMRA, a “Forward Transaction” is a Transaction in respect of which the Purchase Date is at least three Business Days (“three” is actually in square brackets, so that parties can select the number of Business Days that should apply) after the date on which the Transaction was entered into and has not yet occurred. So, if the parties were to execute a Repurchase Transaction today, but the ‘loan’ and the ‘collateral’ are not to be exchanged for another three Business Days (or whatever other period the parties might select), that would be regarded as a “Forward Transaction”.
Annex 1, Paragraph 2(c) of the 2011 GMRA allow the parties to specify whether “Forward Transaction” may be effected under the GMRA. If so, three other provisions apply.
The first of these ‘other provisions’ makes clear that the parties may specify the types of securities that may constitute “Purchased Securities” (i.e. constitute eligible collateral for the loan) by reference to membership of a class. However, in these circumstances, the parties must agree the actual securities that will constitute “Purchased Securities” (in other words the actual securities that will collateralise the loan) not less than two Business Days before the Purchase Date.
The second of the ‘other provisions’ (which is part 2(c)(iii) of Annex I to the GMRA) states that at any time between the Forward Repricing Date and the Purchase Date for any Forward Transaction, the parties may agree either:
- To adjust the Purchase Price under that Forward Transaction (in other words, to adjust the amount of the ‘loan’); or
- To adjust the number of Purchased Securities to be sold by the Seller to the Buyer under that Forward Transaction (in other words, to adjust the amount of ‘collateral’ that is being provided in relation to the ‘loan’).
Why do this? Well, the market value of the securities which form the ‘collateral’ under the ‘loan’ may well have changed in the period between the execution of the transaction and the ‘go live’ date of the transaction (i.e. the “Purchase Date”). This will create exposure for one of the parties. However, it will not be possible to manage this exposure through the normal margining process as the deadline for the minimum settlement period for margin securities will have passed. If the value of those securities has gone down, the Buyer might not be prepared to ‘lend’ as much money or may require ‘more collateral’ in order to maintain the same level of lending. Of course, the opposite is also the case if the value of the ‘collateral’ has increased.
Once the parties agree to some kind of adjustment, an amended confirmation for the Transaction should be promptly delivered.
The third ‘other provision’ has two aspects to it. The first aspect makes changes to the definition of “Transaction Exposure”. The second aspect makes amendments to paragraph 4(c). Both aspects are explained in more detail below.
“Transaction Exposure”
As a reminder, conceptually, “Transaction Exposure” is best understood by asking the question “In relation to a particular Repurchase Transaction, if we terminated this transaction today, who would owe whom money?” The party that is OWED money has “Transaction Exposure” in an amount equal to the sum owed. That exposure is the risk that the party owing that money defaults and does not make payment when due, leaving the party which is owed the money to shoulder a loss. To that extent, “Transaction Exposure” is a measure of the extent to which an individual Repurchase Transaction is either under- or over- collateralised.
With that in mind, the first change (made by paragraph 2(d) of Annex I to the GMRA) is to replace the definition of “Transaction Exposure” that is found within Paragraph 2(xx) of the GMRA with a new definition. The replacement definition has three limbs:
The first limb defines the concept of “Transaction Exposure” in relation to “Forward Transactions”. Specifically, it considers the “Transaction Exposure” of the parties in the period between Forward Repricing Date and the Purchase Date (in other words, in the window before ‘go live’ of the transaction where we can either adjust the amount of the ‘loan’ or require more ‘collateral’ depending on movements in the market value of the ‘collateral’). In these circumstances, the “Transaction Exposure” at any such time is:
TEFT,t = MVPS,t – PPt, where:
TEFT,t = is the Transaction Exposure in relation to a Forward Transaction at time t (‘t’ being any point in time which occurs during the period between the Repricing Date and the Purchase Date);
MVPS,t = the Market Value of Purchased Securities at time t; and
PPt = the Purchase Price.
Taking a step back, what we are essentially asking ourselves is, in relation to a Forward Transaction, in the period before the transaction ‘go live’ – is the market value of the ‘collateral’ (the Purchased Securities) sufficient to cover the ‘loan’ (the Purchase Price) – or conversely, are we over-collateralised?
Technically, the definition of “Transaction Exposure” found at paragraph 2(xx) of the 2011 GMRA assesses “Transaction Exposure” arising in the period between the “Purchase Date” and the “Repurchase” date only, so we do need to make some tweaks if we want to execute Forward Transactions because we also need to manage risk arising during the time period between the “Repricing Date” (at which time we extinguished any then-existing exposure by repricing the transaction) and the “Purchase Date” (at which point margining will kick-in).
The second limb of the amended definition of “Transaction Exposure” defines the concept of “Transaction Exposure” in relation to ‘normal’ Transactions (this would also include “Forward Transactions” once the ‘forward element’ of the Forward Transaction had expired and the trade had ‘gone live’).
It considers the “Transaction Exposure” of the parties in the period between technical ‘trade go live’ and the date on which the Seller actually delivers Purchased Securities to the Buyer (in other words, it is looking at the period when the Seller should have delivered collateral but failed to do so) – this is the period between (a) the Purchase Date and (b) the date on which the Purchased Securities were delivered to the Buyer or the trade was terminated (whichever happens first). In these circumstances, the “Transaction Exposure” at any such time is:
TET,t = MVPS,t – RPt, where:
TET,t = is the Transaction Exposure in relation to a Transaction at time t (with ‘t’ being any point in time which occurs during the period between ‘trade go live’ and the date upon which collateral was delivered (or the trade was terminated – if earlier));
MVPS,t = the Market Value of Purchased Securities at time t; and
RPt = the Repurchase Price.
Taking a step back, what we are essentially asking ourselves is, in relation to a Repurchase Transaction, and during the period in which collateral should have been delivered but hasn’t, is the market value of the ‘collateral’ (the Purchased Securities) which is actually held by the Buyer (presumably, this could be zero) sufficient to cover the ‘loan plus any interest that has accrued’ (the Repurchase Price) – or conversely, are we over-collateralised (seemingly unlikely in this scenario)?
The third limb of the amended definition of “Transaction Exposure” defines the concept of “Transaction Exposure” in relation to ‘normal’ Transactions. It considers “Transaction Exposure” of the parties in the period between (a) the ‘go live date’ of the trade (in other words the “Purchase Date” or the date on which collateral is actually provided to the ‘lender’ or the trade is terminated by the Seller if this is later), and (b) the ‘unwind date’ of the Transaction (i.e. the “Repurchase Date” or, if later, the date on which Equivalent Securities are delivered to the Seller or the Buyer terminates the transaction for non-return of its collateral). In these circumstances, the “Transaction Exposure” at any such time is:
TET,t = (RPt * MR) – MVES,t
where:
TET,t = is the Transaction Exposure in relation to a Transaction at time t (with ‘t’ being any point in time which occurs during the period between the ‘start’ and the ‘end’ of the trade);
RPt = the Repurchase Price at time t;
MR = the Margin Ratio (i.e. the amount of excess collateral we have in order to cushion ourselves against the risk of loss which might result from fluctuations in the value of that collateral. Remember, that the Margin Ratio should be a number higher than one, as it’s basically the market value of the securities on ‘trade go live’ divided by the Purchase Price (in other words, ‘collateral’ divided by ‘loan’)); and
MVES,t = the Market Value of Equivalent Securities at time t.
Taking a step back, what we are essentially asking ourselves is, in relation to a Transaction, and during the ‘life’ of the trade, is the value of the ‘loan plus accrued interest’ due back to us at the end of the trade (as increased by the amount that we have agreed is an appropriate cushion to give us protection against fluctuations in the value of our collateral) GREATER THAN the market value of the collateral that we will have to return at the end of the trade.
Bear in mind that in referencing the “Margin Ratio”, this definition of “Transaction Exposure” is, by implication, only relevant for “Method A”. “Method B” does not use “Margin Ratio” in calculating “Transaction Exposure”. Unfortunately, there is no similar amendment for those wanting to use “Method B” (which is actually the more popular Method of the two). This was actually just an oversight in the drafting of the GMRA schedule and ICMA subsequently published a standard amendment rectifying this mistake.
In all of the three circumstances detailed above, if we end up with a positive number then the Buyer has “Transaction Exposure” (in other words, the ‘lender’ is under collateralised and is therefore exposed). Conversely, if we end up with a negative number, then the Seller has “Transaction Exposure” (in other words, the ‘borrower’ has over collateralised the ‘loan’ and is therefore exposed).
Amendment to paragraph 4(c)
The second aspect of the change that is implemented by virtue of the parties agreeing that part 2(d) of the Annex I to the 2011 GMRA is applicable comes in relation to paragraph 4(c).
In brief, and by way of reminder, Paragraph 4(c) is the clause which defines what we mean by “Net Exposure”. In summary, the concept describes the net amount that either I would owe to you, or you would owe to me, if we terminated all of the transactions underlying the GMRA at the same time. More specifically, I will have “Net Exposure” to you if (a) the total amount of my Transaction Exposures PLUS the amount of unpaid “Income” I am owed by you LESS the amount of margin belonging to you which I hold is GREATER THAN (b) the total amount of your Transaction Exposures PLUS the amount of unpaid “Income” you are owed by me LESS the amount of margin belonging to me that you are holding.
If we agree that part 2(d) of Annex I is applicable then this calculation of “Net Exposure” is expanded slightly. In these circumstances, I will have “Net Exposure” to you if (a) the total amount of my Transaction Exposures PLUS the amount of unpaid “Income” I am owed by you (as well as, broadly, any amount of “Income” that will become payable by you to me in relation to securities ‘in transit’ to you so as to extinguish “Net Exposure” that we’ve just calculated you have) LESS the amount of margin belonging to you I hold is GREATER THAN (b) the total amount of your Transaction Exposures PLUS the amount of unpaid “Income” you are owed by me (as well as, broadly, any amount of “Income” that will become payable to you in relation to securities ‘in transit’ to me so as to extinguish “Net Exposure” that we’ve just calculated I have) LESS the amount of margin belonging to me that you are holding.
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