28 September, 2015
What you need to know
Recent volatility in the markets for Chinese equities and the RMB has caused a number of disruptions. Margin loan, listed share-backed financings and derivative arrangements have been affected in particular, and a number of customers have reacted badly to the news that additional margin must be paid because of a fall in the value of their portfolio or because the mark-to-market value of their derivatives positions has deteriorated. Internal lawyers should be prepared for the questions and challenges that these developments bring, as customers complain and the need to close out and enforce transactions arises.
While the 2008 financial crisis caused many firms to improve their systems and processes for obtaining collateral and, where necessary, closing out positions and relationships, some of this know-how has eroded. It is worth revisiting, with relevant stakeholders, some of the lessons of 2008.
What you should do
Areas for discussion and preparation include: preparing to enforce contracts relating to risky exposures; being proactive with your rights to collateral; ensuring your valuation practices are sound; considering the potential for temporary stays to affect rights against financial institution customers; revisiting your close out and complaint-handling procedures; and ensuring that sensible customer communications protocols are in place and observed.
Here are our areas for discussion and preparation in more detail:
Think and prepare ahead of time. Co-operate with your credit team to identify, prioritise and monitor large exposures. Ensure that all relevant contractual documents are collected in one place, ready for use if and when necessary. Check the documents for anomalies and omissions, and seek to remedy these where possible. Common problems include missing documents, unexecuted documents, inconsistent provisions regarding governing law and jurisdiction and problematic notice provisions (e.g. requiring the service of notices in out-of-the-way places or to addresses that are no longer current).
Collateral. Be ready to seek and obtain collateral as soon as the opportunity arises. Work with your credit team to monitor priority exposures against existing collateral and ensure calls for additional collateral are made promptly and followed up. To the extent that an intermediary onshore security agent holds the collateral, ensure that the agent promptly and properly issues the necessary top-up notices and collects in the additional collateral required. Non-payment of collateral is a useful early warning sign and usually a solid ground for closing out for a failure to pay or accelerating the loan. Check how the existing collateral is being valued and ensure the relevant systems and processes are sound from a legal and regulatory standpoint (see next point).
Valuation of transactions and collateral. Check for illiquid or unusual exposures and consider with your credit and compliance teams the valuation methodology used to calculate collateral requirements and close out valuations. Will this methodology stand up to scrutiny from courts and regulators in the event of a dispute?
Potential for temporary stays for financial institution customers. For customers who are financial institutions with European and/or US branches, check whether your contracts include temporary stay provisions (following the G20 endorsed principles requiring temporary stays for global systemically important and certain other financial institutions). In the absence of express terms, check whether your regulators expect an ad hoc stay to be given to such customers in any case.
Close out procedures. Revisit your close out procedures and ensure that relevant staff understand the main steps. Common pitfalls
include margin calls in incorrect amounts, designating an early termination date which falls
before the effective day of the designating notice, • and insufficiently detailed descriptions of the calculation of the close out (or early termination) amount.
Complaint handling. Ensure that complaint- handling procedures are invoked promptly and diligently if the customer complains to the firm or its regulator. Predictable early steps in a customer complaint include requests for copies of contractual documents between the customer and the bank (invariably provided) and for access to relevant recorded telephone conversations (usually provided where the customer can identify the relevant call(s) and a plausible reason for wanting to listen to it (them)).
Communications. Keep the firm's regulatory responsibilities front of mind when communicating with the customer. A measured tone and approach is usually to be preferred in written communications. Keeping a record of verbal communications can be crucial. Use the protection of without prejudice privilege when handling negotiations with customers and avoid unintentionally forming a contract in negotiations, particularly when using email. Use appropriate "subject to contract" wording (not just the heading) in your communications until a final settlement is achieved.
For further information, please contact:
Gareth Hughes, Partner, Ashurst
gareth.hughes@ashurst.com
