Portfolio Reconciliation and Dispute Resolution 

Michael Clarke 

Managing Director, UBS Investment Bank 

ISDA Collateral Steering Committee Co-Chair 

Jennifer Regan 

Managing Director, JP Morgan 

Discussion with CFTC, Washington DC 

February 14, 2011 
What is an OTC Derivative Margin "Dispute" ? 

Under the Credit Support Annex, "dispute" has a particular technical meaning. A disputed margin call 

may not be cause for concern. 

• "Dispute" is an emotive term. The 

dictionary definition is: 

1. to engage in argument or 

debate 

2. to argue vehemently; wrangle 

or quarrel 

• Under the ISDA Credit Support Annex 

we use the term "dispute" to simply 

indicate where two parties have been 

unable to fully agree a margin call. 

• At the point the margin call is 

disputed, the parties will not have 

examined the substance of the call. 

• Many disputes spontaneously 

disappear in a short period of time, 

and many are economically 

insignificant (see next page). 

• There is a technical reason why one 

must "dispute" a margin call if it 

cannot be fully agreed. Under the 

ISDA Master Agreement failure to 

deliver collateral on demand may be 

an event of default, but the act of 

disputing a margin call provides 

contractual protection against being 

declared in default, while the 

investigation is ongoing. 

Scenario 1 - Fully Agreed Margin Call 

Party A Party A calls Party B for $10 of collateral. 

Party B agrees the call. $10 collateral moves. Party B 

Scenario 2 - Partially Agreed Margin Call (Small Disputed Amount) 

Party A calls Party B for $10 of collateral. 

Party A 

Party B agrees to $9 of the call and disputes the 

remaining $1 . $9 collateral moves and the 

parties may pursue their dispute resolution 

options or "agree to disagree" on the remaining 

$1 , holding additional capital instead. 

Scenario 3 - Partially Agreed Margin Call (Large Disputed Amount) 

Party A calls Party B for $10 of collateral. 

Party A 

Party B agrees to $2 of the call and disputes the 

remaining $8. $2 collateral moves and the 

parties may pursue their dispute resolution 

options (technically they may also "agree to 

disagree" on the remaining $8, holding additional 

capital instead, but this would be rare for a large 

disputed amount). 

Scenario 4 - Fully Disputed Margin Call (with Counter-Call) 

Party A calls Party B for $1 0 of collateral. 

Party A 

Party B counter-calls Party B for $4 of collateral. 

Both Parties dispute the call of the other party. 

No collateral moves and the parties may pursue 

their dispute resolution options (technically they 

may also not pursue their calls against one 

another, holding additional capital instead, but 

this would be rare for a fully disputed or 

call/counter-call scenario). 

Party B 

Party B 

Party B 

2 
What are the Root Causes of Margin Disputes? 

Margin disputes may occur for several reasons, only some of which give rise to economic risk 

Cause 

Valuation Related Issues 

• Timing issues 

• True valuation disagreement 

• Market parameters and observables 

Trade Processing 

• Trades I novations booked incorrectly or late 

• Different booking methodologies between 

counterparties for multi-leg bookings, third 

party fees, etc. 

System & Process Related 

• IT issues 

• System feed issues 

Counterparty Issues 

• Issues with collateral files (e.g. missing trades, 

extra trades, etc.) 

Trade level 

Valuation 

Discrepancies 

Trade level 

Valuation 

Discrepancies 

Trade level 

Valuation 

Discrepancies 

Effect 

Trade level Term 

Discrepancies 

Trade level Term 

Discrepancies 

Trade level Term 

Discrepancies 

Trade level Term 

Discrepancies 

Margin 

Dispute 

Remediating Action 

Q) 

E 

·-IQ) 

E 

·-IMargin 

Dispute 

Management 

Framework 

Key distinction: Trade level valuation discrepancies in the absence of a margin dispute have 

no economic consequence - they are just temporal mismatches between internal records of 

unrealized gains. Industry focus is on differences with economic significance - especially 

disputed margin calls 3 
ISDA Margin Dispute Management Framework 

Since 2008, working in collaboration with the ODSG*, the industry has developed a multi-layered 

approach to managing margin disputes 

Internal Firm Firm to Firm Legislation I Regulatory Commitments 

Practice Industry Rulemakings Capital 

Practice 

Avoidance ~ ~ ~ (Portfolio Reconciliation) 

Prompt ~ ~ Investigation 

Escalation ~ ~ 

Transparency ~ ~ 

~ ~ ~ Resolution Methodology Timing Economic 

Consequence 

Intractable Dispute ~ ~ ~ ~ 

Management Methodology Timing Economic 

Consequence 

* OTC Derivatives Supervisors Group 4 
Dispute A voidance - Portfolio Reconciliation 

The ISDA Dispute Management Framework has been highly successful in reducing difference and disputes 

Current Practice 

• Daily Portfolio Reconciliations between G14 (June 2009) 

• Portfolio Reconciliation between G14 and their counterparties with >1 ,000 trades (July 201 0) 

• APAC Portfolio Reconciliation Memorandum of Understanding (January 2011) 

1.8 Enhanced reporting : Mismatch rates with Gl4 dealer counterparties 

CSA:~ with more than 500 tJ·ade::J a re included 

Volume weighted average v~l ue:o 

Mismatch rates 

o~ unmatched 

s~>i.· 

6e·~ 

1\~-'r. 

2% 

D"'ii 

5 6 s I) 10 ll ~2 15 16 !7 

Dealer 

Monthly reports provided to the supervisors on G14 

portfolio reconciliation results show valuation 

differences are minimal 

0.0250% 

0200% ~ 0 .0150% 

0.0100% 

0.0050% 

The percentage of valuation differences in the overall 

portfolio is relatively small when compared with term 

discrepancies. Below is a chart depicting the levels of 

valuation differences month on month throughout 2009. 

Industry Average· Valuation Differences Month on Month 

0000% 1---~-- ~---~---~- ---------- --~---~--~ 

Jan-09 Feb-09 M ar-09 Apr-09 M ay-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 

Historical trend of valuation differences throughout 2009 

show that at its peak, valuation differences made up only 

0.025% of overall portfolios. 

Note: The spike in June is a data collection artifact attributed to the reporting 

changes that were implemented: 

- Moved from a $20mm threshold to a risk based threshold per product 

-Moved from reconciling portfolios of >5,000 trade to >500 trades 

5 
ISDA Margin Dispute Convention and MPP Drafts 

The final part of the ISDA Dispute Management Framework is the creation of market standard 

documentation to govern the investigation and resolution of truly disputed margin calls - this is Work-inProgress. 

• 2010 Convention Draft - 30 Calendar Days 

- Daily use during business as usual circumstances 

- Method for investigating disputed portfolios; includes steps such as 

performing a portfolio reconciliation 

identifying transactions driving the dispute 

senior level escalation and discussion (intra and inter-firm) as needed. 

- 30 days has been debated extensively, but is necessary because the time period must allow for: 

Time to obtain both parties' data to reconcile 

Time to perform the reconciliation and study the results 

- Time to investigate results of interest, which may involve different desks and timezones. Some investigations are complex and take 

several days 

Time to review with senior management and obtain necess'?ry risk, ac9ounting. leqal, trading and other approvals for P&L 

adjustments 

- Time for senior consultation between firms to occur; which may involve' individuals With intensive schedules, who may be travelling 

and who may be in different timezones. 

Note that in extremis the 30 day period can be accelerated to zero days, with the MPP invoked immediately. 

• 2010 Market Polling Procedure (MPP) Draft-18 Local Business Hours 

- Lays out the procedure and conduct for disputing parties to execute a Market Poll 

- Evaluation gives precedence to two-way, firm, executable quotes 

- Evaluation attempts to synthesize the real market (tightest bid and offer) 

- Results are bound by the Mid Market Values and Executable Quotes (if any) 

- The MPP will always lead mechanically to a result, although in the absence of any independent values and with neither party willing to 

make a firm , executable price the result may be based on splitting the difference between the views of the counterparties. 

- The MPP is a complex and intensive process that is not intended to be used frequently or for large numbers of transactions. 

- Disputing parties are strongly encouraged to resolve their differences consensually under the Convention. 6 
NOTE DETAILS SUBJECT TO CHANGE 

Annex 1 • 

• Overview of the Convention and MPP Drafts 

0 

0 + 30 

0+30 + 2LBH 

0+30 + 8LBH 

0+30 + 14LBH 

Disputed Margin Call 

Administrative Review (20 Calendar Days) 

Promptly exchange portfolio data (Mandatory) 

Perform a portfolio reconciliation 

Investigate the dispute and consult with each other as to that investigation 

• Any disputes unresolved after 20 Calendar Days goes to Senior Consultation, in addition to 

continuing the Administrative Review 

Senior Consultation (10 Calendar Days) 

Either party may deliver a Senior Consultation Selection Notice 

Senior level escalation and senior level firm-to-firm discussions as needed 

• Any disputes unresolved after 10 Calendar Days goes to Market Polling 

Polling Process Consultation (2 Local Business Hours) 

• Disputing Party initiates via telephone and written notice to other Party's Senior Official 

Each Party will: 

- Identify Reference Independent Price Sources (RIPS) it intends to solicit for Quotes 

- Agree Announcement Time; default is6 LBH after Quote Gathering Starts 

- Agree Transaction Size; default is commercially reasonable 

Quote Gathering (at Announcement Time - 6LBH is default) 

Each Party may solicit as many Quotes as it wishes from the RIPS 

At the end of Quote Gathering, each Party must submit (as of Announcement Time): 

- Their Mid-Market Value 

- Optionally their Executable Quote 

- All the Quotes obtained from the solicited RIPS (Executable or Indicative) 

Quote Evaluation (6 Local Business Hours) 

Collated Quotes are evaluated to determine the Result 

There are 3 possible scenarios 

- Two or More Executable Quotes 

- One Executable Quote 

MPP Result Obtained 

---

Move 

Undisputed 

ldl 

Move Additional 

Collateral for 

Consensually 

Resolved 

through 

Move Additional 

Collateral* 

ISDA CSA New York LawParagraph 5. Dispute Resolution 

at the Notification Time 

OR 

ISDA CSA English LawParagraph 4. Dispute Resolution 

- at the Notification Time 

ISDA CSA New York LawParagraph 5. Dispute Resolution 

at the [Resolution Time] 

OR 

ISDA CSA English LawParagraph 4. Dispute Resolution 

-at the [Resolution Time] 

*Failure to Move Collateral 

Results in an Event of Default 

7