At the ACT summer keynote address Lehman administrator Tony Lomas issued a chilling warning to corporate treasurers about counterparty risk. The collapse of Lehman may have happened nearly three years ago but it is clear that the lessons have not been learned by all those involved: politicians, regulators, the financial services industry and their clients, including treasurers.
A bank collapse is the classic "black swan" event. It may be rare but if it happens it auses huge difficulties for those involved. Lomas gave one example of the legal complexities that can quickly engulf the unwary corporate and the unprepared treasurer: the prime brokerage agreement. He argues there are two basic types of prime brokerage agreement but that so many variations of those agreements have been introduced over time that no two are the same. In his experience many of these agreements are unread by the bank’s counterparty so they don’t know and don’t understand what exactly the document says. In the routine course of business this probably doesn’t matter too much because in normal circumstances it is the operational nature of the relationship that is important. But when one party collapses it is the legal issues that count.
The keynote address audience heard that some agreements specify that counterparties can do whatever they want with the assets handed over to them and if it all goes belly-up they only have the right to claim as an unsecured creditor. That may be mad but that is what corporates agreed with Lehman, sure in their belief that the worst scenario would never come to pass. Fancy explaining that one to the boss or the board?
We all now realise that any counterparty could go bust. And if your company has a complex legal relationship it is vital to understand in advance what the consequences of such a collapse could be.
Of course, this is a real disaster scenario, but wise treasurers will make sure they know where all their important legal documents are, what they say and what that means – in any eventuality.
PETER WILLIAMS
EDITOR
