Market Volatility - Challenging Margin Calls: Investors' Rights, Remedies and Potential Claims

This is our second post concerning the legal implications for investors of market volatility under English law governed transactions. In this series, we examine investors' rights, remedies and potential claims when markets get choppy — including in light of the recent volatility in the gold, silver and equities markets. 

This week, we look at how investors may seek to challenge live margin calls. 

Failure to comply with calculation or notice obligations

In certain cases, it may be possible to dispute the legal validity of a margin call on the basis that applicable contractual provisions relating to the calculation and notification of calls have not been followed. The following key points should be borne in mind:

• Typically, the bank or other institutional counterparty will be the calculation agent and responsible for calculating the margin call. If a margin call is suspected to be wrong, it is important to understand how the calculation obligation works, and what the constituent parts of the call actually are. This will be a matter of interpreting the contract and reviewing the available evidence, including prior calls. For any ISDA-governed positions, investors will need to take account of any bespoke selections and modifications made by the parties in the Schedule to the ISDA Master Agreement and/or in any trade Confirmations. If the contract has not been complied with, there may be an argument that the margin call is invalid.
• As a practical step, it is important for investors to collect promptly any evidence relating to the margin call in question, including market data for any underlying reference assets, outputs and screenshots concerning the constituent parts of its calculation, contemporaneous emails and any recorded telephone calls with the calculation agent.
• For contractual obligations concerning notice, an avenue of challenge may be that the calculation agent did not comply with (for example) its notice obligations under an ISDA Master Agreement and, specifically, the strict notice provisions in section 12. Demands under a Credit Support Agreement (1995) or CSA (VM) (2016) must comply with those overarching requirements, unless they have otherwise been modified by the parties. The notice provisions in the ISDA Master Agreement are generally more tightly construed than in other types of contracts.[1]
• For ISDA transactions, the bank or broker-dealer typically performs the role of the Valuation Agent (as defined respectively in the CSA or CSA (VM)). In short, the Valuation Agent is obliged to calculate the value of the collateral (i.e. margin) amount demanded from an investor/counterparty. As we will discuss in our next post, under a CSA, the valuation agent has a duty to perform its margin valuation obligations “in good faith and in a commercially reasonable manner”.[2] Accordingly, any calculation of Exposure, Delivery Amount (CSA), Delivery Amount (VM) and Value may be susceptible to challenge on this basis. 

What is the loss?

The key question for potential claims arising from breaches of calculation or notice obligations is to identify the actual loss that the investor may have suffered. Putting to one side wrongful termination scenarios that we will discuss in a future post, if the margin call was only incorrect by a small amount, or the bank could have called for margin the next day anyway, then there may have been no meaningful loss suffered by the investor. However, investors may be able to prove they have suffered loss by, for example, being deprived of the funds used to satisfy the margin call where it was particularly significant in size, and there was a reasonably available alternative investment opportunity that would have otherwise earned a return. To pursue any such claim, the investor will need detailed factual and/or expert evidence, supported by contemporaneous documents.

Practical step: Margin call dispute plans

One practical step any investor that may be at risk of receiving a disputed margin call should take is to prepare in advance for the eventuality by drawing up a margin call dispute plan. In summary, these are pre-planned workflows which set out the deadlines, legal pathways, expected actions and escalation triggers if and when a margin call becomes the subject of a dispute. Ideally, they should be prepared with the benefit of advice from specialist litigation counsel, and have regard to the investor's specific product and counterparty exposures. For example, these workflows could include:

• A review of the investor’s portfolio of ISDA Master Agreements and related trade documentation, given that (for example) the procedures may differ depending on whether the CSA is the 1995 or 2016 version, or if the parties have agreed bespoke calculation formula in an ISDA Schedule, Confirmation, or prime brokerage agreement specific to the counterparty.
• A graphical timeline of a non-disputed margin demand under a CSA and the contractual timing of a counterparty’s response. Such timing may differ depending on the type of demand. Assuming the margin call is governed by a 2002 ISDA Master Agreement, if the demand is purely for cash, then the counterparty only has one business day to transfer the cash margin. If the demand is mixed for cash or securities, the counterparty takes the benefit of T+2 settlement terms for securities, even if the counterparty actually decides to transfer cash (see paragraph 3(a) of the CSA)).
• A graphical dispute timeline of a disputed margin demand for (e.g.) structured derivative products. This could take the form of a flowchart of the different legal pathways, deadlines and decisions required, in order to ‘wargame’ in advance what the counterparty should do if it is facing a disputed margin call and/or collateral valuation.
• Pre-defined scenarios in which potential disputes will be escalated from the trading desk to in-house or specialist external legal advisers.
• Identified outside counsel contacts who, in the ideal scenario, will have been involved in drawing up the plan itself, and will therefore be familiar with the applicable contractual frameworks, the nature of the portfolio's exposures, and be able to advise promptly on any issues which arise.

Front-loading this work saves time during the critical period where an investor is considering making a challenge, sometimes with critical deadlines to meet on that business day (or the next). Should your business wish to explore whether pre-planning of the kind suggested would be beneficial, we would be happy to discuss.

In our next post, we will look at investors' rights in collateral valuation disputes.