Account for how disputes over collateral are reconciled.
The idea
Collateral disputes arise when the two parties compute different calls. Typical causes are mismatched trade populations, different valuation models or market data and timing, different collateral valuation, or errors in the agreement's terms. The usual contractual process has the disputing party notify promptly, transfer the undisputed amount without delay, and then resolve the rest, often by recalculating with quotes from reference market makers or the party's own pricing evidence. Over the longer term, portfolio reconciliation, comparing trade-by-trade valuations and data, removes the causes. Disputes matter for risk because they lengthen the effective margin period of risk and raise exposure and capital. The exam trap is that a dispute does not excuse withholding the undisputed part, and failing to deliver that part can become an event of default.
A practice question
A counterparty disputes a margin call. What should it do first under standard dispute procedures?
- Terminate the transactions, since a dispute is a termination eventWhy not: A dispute alone is not a termination event.
- Pay the full amount demanded and reclaim any excess at quarter-endWhy not: Only the undisputed amount is required, and overpaying needlessly leaves the pledgor over-collateralised.
- Notify promptly and transfer the undisputed amount while the rest is resolved - correct
- Withhold the whole call until the dispute is fully settled by both partiesWhy not: The undisputed portion is still due and cannot be withheld.
Standard terms require prompt notice of the dispute and transfer of the amount not in dispute.
A harder one
A dealer calls USD 12 million. The counterparty's own calculation, on the same terms, gives a call of USD 9 million. Which amount should be transferred immediately?
- USD 12 millionWhy not: Transfers the full call; only the undisputed amount is due.
- USD 10.5 millionWhy not: Splits the difference; no rule sets the undisputed amount as the midpoint.
- USD 3 millionWhy not: Transfers only the disputed difference instead of the undisputed amount.
- USD 9 million - correct
The counterparty agrees that 9 is owed, so the undisputed amount is 9; the remaining 3 is resolved separately.
The hardest tier
A dealer computes exposure of USD 40 million, a threshold of USD 10 million and collateral held of USD 18 million, and calls USD 12 million. The counterparty values the portfolio at USD 33 million, with the same threshold and collateral. What is the undisputed amount?
- USD 12 millionWhy not: Treats the dealer's whole call as undisputed.
- USD 8.5 millionWhy not: Averages the two calls instead of taking the amount both accept.
- USD 5 million - correct
- USD 15 millionWhy not: Omits the threshold in the counterparty's calculation: 33 - 18.
Counterparty's own call = 33 - 10 - 18 = 5. Both agree on at least 5, so the undisputed amount is USD 5 million; the other 7 is disputed.
In the app: 6 practice questions on this outcome, spaced review that brings it back before you forget it.
Start free →More in Margin (Collateral) and Settlement
- Outline why collateral is managed.
- Set out the terms found in a collateral agreement and the main features of a credit support annex (CSA) in an ISDA Master Agreement: credit support amount, credit quality, haircuts, rounding, minimum transfer amount, initial margin and threshold.
- Compute the margin, meaning the credit support amount, under a number of different scenarios.
- Outline what a valuation agent does.
- Outline how collateral operates in practice and the kinds of collateral commonly used.
- Spell out what a collateralization agreement typically contains.
- Distinguish CSAs that run one way from those that run both ways, and describe how collateral parameters can depend on credit quality.
- Account for collateral-related aspects such as funding, rehypothecation and segregation.
- Show how collateralization can bring about market risk, operational risk and liquidity risk, funding liquidity risk included.
- Set out the assorted capital requirements imposed by regulators.