The last several years have seen a rise in the amount of disputes with respect to the valuations of derivatives, principally as result of the insolvency of Lehman Brothers and its affiliates in 2008. As a number of these litigated matters have been settled, finally litigated or are winding down, a brief review of the recent developments may be instructive.

Under the 1992 International Swaps and Derivates Association (ISDA) Master Agreement close-out process, the parties can elect between two methods: ‘Loss’ and ‘Market Quotation’. ISDA modified the standard documentation in 2002 and made a number of changes, including permitting the parties to use both market quotations, loss and other methodologies as long as any close-out amount is determined in good faith, using commercially reasonable procedures in order to produce a commercially reasonable result.

Considerations in conducting a market quotation process

The Market Quotation method requires the non-defaulting party to contact four leading dealers in the relevant market to request quotations that would “have the effect of preserving for such party the economic equivalent” of the transactions. For those derivative positions for which more than three quotations are provided, the Market Quotation must be the average without regard to the highest or lowest values. If exactly three quotations are provided, the remaining quotation after discarding the highest and lowest is selected. If fewer than three quotations are provided, then it will be deemed that the Market Quotation cannot be determined and the non-defaulting party must revert to Loss.

Jan-Mar 2018 issue

Hogan Lovells US LLP