UK: Ascertaining Fair Market Value For "Repo" Trades Under GMRA Standard Terms

Last Updated: 25 April 2018
Article by Felicity Ewing, Thomas Leyland, Matthew Sapte and Tanya Alfillé

In the recent decision in LBI EHF v. Raiffeisen Bank International AG [2018] EWCA Civ 719, the Court of Appeal has considered the close-out valuation provisions for "repo" trades entered into under a Global Master Repurchase Agreement (2000 edition). The court refused to limit the wide discretion given to a non-defaulting party to determine fair market value under the GMRA.

The factual background

The two banks had an ongoing trading relationship. When LBI failed and went into insolvency in October 2008, it had open positions on some of its trades with Raiffeisen, including 11 "repo" trades subject to the terms of the related GMRA. (Repo trades are economically, if not legally, a form of collateralised lending. In this case, LBI sold a portfolio of debt securities to Raiffeisen and agreed to repurchase equivalent securities at a later date and at a predetermined repurchase price. The initial purchase price paid by Raiffeisen represented the financing amount, and the repurchase price to be paid by LBI represented repayment of this amount, together with an amount representing interest.)

Following LBI's failure, Raiffeisen served default notices under these trades. Under the GMRA, LBI was required to pay Raiffeisen the agreed repurchase price minus an amount representing the "Default Market Value" of the repo securities, to be ascertained by Raiffeisen as the non-defaulting party.

LBI disputed Raiffeisen's valuation, which was based on the information available to it at the time of the default. This consisted of bids invited from counterparties, algorithm-based prices on Bloomberg and its own activity around that date. LBI argued that the relevant provisions of the GMRA required Raiffeisen to make its assessment without reference to any pricing information that reflected the distressed nature of the market at that time.

Valuation under the GMRA

The GMRA provides for various methods of ascertaining the Default Market Value (paragraph 10(e)(i) of the GMRA). These allow for the Default Market Value to be determined by reference either to the sale price of the repo securities (if sold in good faith), or to commercially reasonable quotations obtained from market makers for such securities or, where a sale or quotations are not possible, to the "Net Value" of equivalent securities. A valuation similarly based on net value of equivalent securities must also be used in all instances where the default valuation notice has not been served by the default valuation time (paragraph 10(e)(ii)). This was the sole valuation method open to Raiffeisen because its default valuation notices had been served after the default valuation time.

"Net Value" is defined in paragraph 10(d)(iv) as:

"... in relation to any [securities], the amount which, in the reasonable opinion of the non-Defaulting Party, represents their fair market value, having regard to such pricing sources and methods (which may include, without limitation, available prices for Securities with similar maturities, terms and credit characteristics as the relevant Equivalent Securities or Equivalent Margin Securities) as the non-Defaulting Party considers appropriate ...".

The principal issue to be determined at trial was the meaning within that definition of "fair market value".

Judgment at first Instance

The court at first instance rejected LBI's contention that, based on definitions of fair market value in other contexts, "fair market value" under the GMRA should exclude prices or quotes achieved in a distressed market. Such a meaning would be inconsistent with the terms of the GMRA which allowed a non-defaulting party to sell the securities in what might be a distressed market and determine the default market value on the basis of the prices obtained, provided it had acted in good faith.

Instead, the court focused on the broad discretion conferred on the non-defaulting party under the GMRA, entitling it to have regard to whatever pricing sources and methods it considers appropriate, provided it has acted rationally. This required a careful examination of what the non-defaulting party contended it would have taken as "fair market value" and why. Having carried out that exercise, the court was satisfied that Raiffeisen's approach was rational and it had made an honest determination of "fair market value".

LBI appealed that decision.

The appeal decision

The appeal was dismissed on the basis that, under the GMRA, a non-defaulting party has a wide discretion to assess "fair market value" by reference to whatever sources it considers appropriate, and any limitation of that discretion requiring it to exclude evidence of the market at the time merely because it was illiquid or distressed is unwarranted.

The Court of Appeal considered the starting point to be the GMRA definition of "Net Value", which gives the non-defaulting party a wide discretion to assess "fair market value" by reference to "such pricing sources and methods ... as [it] considers appropriate". As a matter of principle, the only limitation on the exercise of such a broad discretion (in the absence of an express or implied limitation in the contract) is that the decision-maker must have acted rationally, and not arbitrarily or perversely.

The court did not accept LBI's contention that the meaning of "fair market value" requires the non-defaulting party to make an assessment of the price from the perspective of an unimpeded/willing buyer and unimpeded/willing seller, neither being under any particular compulsion to trade, which should therefore not reflect any illiquidity or distress in the market at the time. Such a limitation was not found in the express terms of the GMRA. Nor should it be implied given that it was contrary to the express language of the GMRA and, in particular, the wide discretion conferred on the non-defaulting party.

As to the meaning of "fair market value", the court was not persuaded that the Commonwealth cases relied on by LBI were of assistance as they involved different factual contexts. The meaning of "fair market value" has to be determined as a matter of construction of the particular contract in its particular context. The only other case that has considered the relevant GMRA provision is Lehman Brothers International (Europe) v. Exxonmobil Financial Services BV [2016] EWHC 2699 (Comm). In Exxonmobil the judge considered that the exercise of the assessment of "fair market value" was broad and subject only to the non-defaulting party acting rationally. That case also proceeded on the basis that such assessment would have involved consideration of the market at the time of Lehman's collapse in September 2008, when the market was distressed. Such an approach was entirely consistent with the GMRA terms which expressly entitle the non-defaulting party to have regard to whatever "pricing sources and methods" and to such "available prices for [s]ecurities" as it considers appropriate.

The court also considered the Guidance Notes to the GMRA and FAQs published by ICMA to be of little assistance in construing its terms, and suggested that labelling the FAQs as "for information only" in any event rendered them almost certainly impermissible as an aid to construction.

Implications of the LBI decision

The decision confirms the general approach taken in the Exxonmobil case, making it clear that the wide discretion given to a non-defaulting party in determining the basis for its valuation under the GMRA should not be limited, as long as its determination is made rationally. The court in the LBI case focused on the express language of the GMRA and rejected attempts to impose a meaning which ran counter to its terms.

The Exxonmobil and LBI decisions were both based on factual scenarios arising out of the global financial crisis. Whilst it is to be hoped that such economic conditions do not reoccur, the court's general approach to the interpretation of the GMRA terms in these cases is likely to have wider application, beyond the specific close-out provisions considered here. So, where its express terms are clear, the courts are unlikely to be willing to impose an interpretation from sources outside the GMRA terms themselves. This is no doubt to ensure that parties entering into such standard form documentation can have some certainty as to the terms by which they are being bound.

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