You’re all here for eternity which, I hardly need tell you, is a heck of a long time.
—Rowan Atkinson, Welcome to Hell
Every now and then I field an unsolicited offer from someone to help me with “search engine optimisation”. This person says something along the following lines:
“In the competitition for attention on the world wide web, getting to the top of the google search results is more important than ever. I can help boost your site in search algorithms, so you rise above your competitors.”
Smugly, I always tell these people the same thing:
“Look, chump: I write weak satire about financial derivatives. I don’t have any competitors. No-one else is that stupid.”
The JC’s basic gig is to investigate the background context about things that are usually taken for granted — or ignored — to shed light on the business, economics and rationale of capital markets activity.
It is all pretty arcane, dry stuff. By design, I tend to think: the dense thicket of bumferous tedium is an imposing barrier to entry — “moat” is the latest buzzword. It keeps insiders at an advantage. My own attention-span is short so, while I was scaling that barrier, to keep myself interested, I resolved to make it fun to write — and therefore fun to re-read. There’s a mnemonic quality to it too: the more colourful you can make it, the easier it is to remember.1
So the JC presents material in an off-beat way. Since industry is populated, largely, by “on-beat” people — the financial services industry doesn’t exactly encourage loose cannons — I often wonder who my audience is. The answer I usually settle on is, “me”. But there is a small band of fellow travellers out there. The loose cannons. The inquisitive. The easily bored. I know it. You keep your cards close, but you know who you are. So I box on.
In any case The Jالی Contrarian™ started as a handy, non-linear way for this low-trajectory loose cannon to store “tacit” knowledge as he went along: crib notes, good practice, bad practice, old wives tales, wry observations and functional know-how about who does what, why, and the practical ins and outs and theoretical background to these mad legal contracts. And here, fifteen or so years later, we are.
The thing about tacit knowledge is that it is tacit: forty or more years of people doing, but not writing down, this stuff means there tend to be large holes in the record, here and there, where institutional memory has disappeared altogether. Here I have feely made stuff up, a series of “just so” stories to put this into some kind of context, even if it is a false one. I have recently completed a long series about collateral that was like that.
It is not easy to write entertainingly about swaps. Rib-ticklers do not exactly leap off the page: there are no star-cross’d lovers, dark and handsome strangers, boy wizards or bunny-boiling sociopaths. Actually, I am not sure about this last one: there is something of the Hannibal Lecter about those prepared to write tomes about aleatory contracts, a topic we will shortly get to.
But even so, there are levels of dullery. Variation margin is one thing: you can crowbar in Jimi Hendrix anecdotes and Monkey! references into that.
But close-out netting? We are on a different level here, readers: it isn’t just arcane and technical: it is, at a fundamental level that even the most ardent ninja will feel to her marrow, stupefyingly dull.
So we will try to liven it up with a little Kabuki theatre for you all, from the pen of that finest exponent of finance fiction, Hunter Barkley. This is from his forthcoming novella Close-out! Close-out! Close-out!.
The warehouse was dark. Condensation dripped. Water pooled. Steam hissed.
Algy led. Boone stayed close. They ran silent: matched strides. Tracked footprints. They moved like feral cats.
They went room to room. Algy cleared left and right. He cleared out the corners. He waved them through.
They made it to the central chamber. It was dark. They went in.
A solitary downlight picked out the Hackthorn goon: Cass Mälstrom, C.O.O. He sat at a card table in the middle of the floor. He had game. He was ex-McKinsey. A real thought-leader. He sat tight. He didn’t move.
Boone coughed.
Mälstrom looked up. “Is that you, Boone?”
“Yes, Cass, it’s me.”
“You alone?”
“Look, I just want to sort this out. I didn’t want this — none of us did — but you gave us no choice. Why didn’t you pick up the phone, Cass?”
“I — I been busy, Opco.” Mälstrom seemed edgy. He clocked Algy. “Who—hey, who’s that? I said come alone! I said no fuzz, Boone.”
“Algy’s not a copper, Cass! He’s my bagman. He’s got what you want, if you’ve got what we want.”
Boone nodded at Algy. “Show him, Al.”
Algy opened the kimono. He flashed his trench. He dangled his wares. MTMs glittered from the lining on either side.
Mälstrom whistled. “Pretty.”
“So, we got ours, Cass. Now, how’s about you?”
Mälstrom swallowed. Beads pricked on his pink forehead. “It’s — it’s a—all here.” Mälstrom seemed suddenly nervous. He motioned at a calico sack on the desk, next to a fruitbowl.
Algy muttered, “What’s with the summer fruit, Opco? I don’t like it. Something ain’t right.”
Boone held up a finger. “We showed you ours, now you show us yours. Just let us see what you have, Cass, and we can be on our way. We just want what’s owed to us. We don’t want any trouble.”
Another voice came out of the dark. Urgent. Malicious. “Who said anything about trouble?”
A loud click. Boone knew at once: it was the sound of a bump-stock OSLA being cocked.
“Wh—?”
“Not so fast, Mr. Boone.”
Boone said, “I say, who is this?”
“Your worst nightmare.” A long glinting copper barrel moved into the spotlight throw and pressed against Mälstrom’s temple.
Mälstrom squeaked. “Just do what she says, Opco. Just do it. Sh — she’ll kill me! I’ve seen what she can do! She’s not kidding around!”
A tall woman in black chiffon moved into the light. “I don’t believe we’ve met, Mr Boone. I’m Emsworth, of the O. A.”
“A banko!” hissed Algy.
“Yes, Mr. Farquhar, a “banko”. A liquidator. A receiver with a mandate to resolve. Hackthorn Capital Partners L.L.P. is my baby now. My baby, and your problem. Now, let’s have your MTMs, Mr. Boone. Nice and slow. Come along.” Emsworth reclicked the OSLA and shoved it against the hedgie’s temple.
Mälstrom re-squeaked. “Do it, Boone!”
“Put down your money, Mr. Boone.”
Boone nodded to Algernon.
Carefully, Algy placed the MTMs down, one at a time. “I did all the calculations just like you said I should, Opco, under Section 6(d). I gots all the statements.”
“Ok, Al, count them off.”
Algy busied himself around the table, placing bags in a row. “Here’s our forty five for you. For this next one, you have to put down twenty six for us. We put twenty two for you. You put eighty five down for us.”
It took fifteen minutes. Algy stood back, proud of his work.
Emsworth smiled. “Goooood. I like it when people are sensible.”
“All right, Ms. Emsworth. You’ve had your fun,” said Boone. “Now it’s your turn.”
Algy nodded. “Right. So now you gots to put down your OTMs too. The ones for us.”
Emsworth chuckled. “I don’t think so.” She swept Algy’s piles into a black Samsonite and snapped the lock.
“Hey!” squeaked Algy.
Boone took a step forward.
Emsworth re-cocked the OSLA. “Easy, now: let’s not do something we’ll any of us come to regret, Mr. Boone.”
Boone stopped. “All right, all right: but this is not how it’s supposed to work, Ms. Emsworth. That’s not the deal. We settle down. We net, positives against negatives. Tell him, Cass.”
Mälstrom whimpered.
Emsworth twisted her face into a long, deep, cruel laugh. “Oh, Mr. Boone. You poor deluded fool. This is Guatemala. You’re not in Kansas any more.” She reached over to the fruitbowl, plucked a cherry and raised it slowly to her thin lips.
“Jeepers, Boone, look out! I think she’s — cherry-picking!” cried Algy.
Emsworth smiled and bit. The fruit burst. Crimson juice ran down her chin.
“I say, Mr. Boone, your little monkey is perceptive. I am “cherry-picking” — just as I am entitled to do.”
Opco said, “Now look here. This is a single agreement! We square up. That is the deal! What about your OTMs? What about the money you owe us?”
“But, Mr. Boone: we are through the looking glass now. We hav emade the phase transition from the normal world into bankruptcy. The normal rules do not apply. Now, if you’ll excuse me, I have what I need, and I have a plane to catch.”
“What about my money, Emsworth?” Emsworth yanked a circuit breaker and another downlight glared. “If you want your OTMs you shall have to wait for them. And fight for them.” The spot revealed a rusted metal cage. A dozen big cats paced inside: leopards. Tigers. They growled.
“What the hell is this”?
“Can’t you read, Mr. Boone?”
There was a stencilled sign above the cage: “CREDITORS”.
“Mr. Mälstrom’s creditors. You are welcome to join them. They are all looking a bit peckish, don’t you think, Mr. Boone? Shall we feed them?”
Emsworth dangled the MTMs.
“Stop this! Tie them up!”
“Tie them up? Oh, no, Mr. Boone. That would never do. They are unsecured. If you want your money, you’ll have to scrap them for it.”
Emsworth lobbed the calico sack into the cage. The big fat cats fell upon them in a threnody of gnashing maws.
“All yours, Mr. Boone! Good day!”
Official Assignee, First Class M. T. Emsworth threw the circuit breaker. The room went black to the reverberating sound of her calculating laughter.
“Nein!” Ogfried sat bolt upright, drenched in sweat.
A light clicked on. He blinked.
The Gräfin stirred, rolled over, pushed up her sleeping mask and regarding her husband painedly. “Vot is eet, darlink?”
Herr Ogfried Schümli Pflümli ranking workstream lead of the Basel Committee’s special execution disaster planning taskforce, grunted.
The dripping warehouse was gone. The lions were gone. The calculating Guatemalan receiver, M. T. Emsworth, was gone. He was in his bed, a comfortable four-poster in his favourite suite at The Meadows. A gossamer curtain billowed by an open window. Outside, the forbidding crests of the Jungfrau were bathed in starlight.
The Gräfin said, “Ach —you hef a nightmare, sweetheart.”
Schümli Pflümli blinked again. His suite was still there. No lions. But — it seemed so real. So urgent. So dangerous. So — plausible. Was it really — could it have been — just a dream?
“Nein,” he said to himself, out loud. “Zis could really happen. We must do something.”
It is Schümli Pflümli, in Barkley’s telling of it, that we have to thank for the current, grisly state of the world.2 The poor man saw the risk that bankruptcy administrators posed to the financial universe, and made it his life’s mission to stop that catastrophe ever happening, by requiring comprehensive legal opinions on the effectiveness of the Single Agreement for every counterparty in every jurisdiction, for every master agreement.
By one measure this has been the most successful regulatory innovation in the history of finance: as far as I know, not a single master agreement has had its integrity challenged in insolvency by any liquidator anywhere in the world.
But on the other hand, some people say that, as a disguise, elephants paint the soles of their feet yellow and hide upside down in custard.
As far as I know, no-one has ever seen an elephant hiding upside down in custard, either.
For all that, though, netting and capital adequacy is a very useful lens to understanding how the market works, and why it takes the shape it does. The whole palaver is also, in my view, badly in need of fixing.
Today we start to confront, in all its majestic, horrifying glory, the problem of close-out netting.
The netting problem
This topic — “the capital treatment of close-out netting, what is wrong with it and how to fix it,” has been flapping around my head like a wounded pigeon for a decade.
All in-house sales & trading lawyers will know the problem well, for it is their problem. Our problem: to identify, gather, read, analyse and summarise “written and reasoned” close-out netting opinions covering every master netting agreement in the bank’s portfolio. These opinions might be anything from thirty to three hundred pages long. Each.
Now, no-one wants to read a netting opinion. No-one. Given the lengths their authors go to spin the blessèd things out it might seem improbable, but I don’t believe anyone wants to write a netting opinion, either.
But they do. By the boatload. In the year of our Lord 2026, a good-sized trading broker-dealer is likely to have hundreds of thousands of master agreements. Each of them must be covered. A given firm may need several hundred permanently-updated opinions. The sheer drudgery of this exercise defies simple description. You have to start reading just one of these opinions to understand it. So, actually, let’s do just that. To make the point. Here is sample paragraph, from page 26 of a 107-page opinion:
It occurs that, mainly because of the applicable limitations on asset allocation (spreading of risk) and also because the Investmentfondsgesetz contains specific provisions on the redemption of the Investment Fund’s units (and certain limitations/precautions in case redemption should lead to a liquidity problem), the Investmentfondsgesetz is based on the assumption that an Investment Fund may not become overindebted in terms of Austrian insolvency law (insolvenzrechtlich überschuldet) or illiquid (zahlungsunfähig). Accordingly, save for provisions that relate to an Investment Fund’s liquidation (Abwicklung) (e.g, in case the Investment Fund’s assets decrease below EUR 1,150,000 and the Investment Fund Management Company opts to no longer manage that Investment Fund and no substitute Investment Fund Management Company is appointed in accordance with the Investmentfondsgesetz), applicable law is silent in this regard. In our opinion this (historic) view somewhat neglects to take into account the risks that may be incurred by the Investment Fund Management Company, e.g. in relation to derivatives transactions that are entered into by the Investment Fund Management Company in its name and for the account of the holders of units in the Investment Fund (Anteilinhaber) in respect of a specific Investment Fund.3
And that is just one opinion, for just one agreement type, in just one jurisdiction. Capital regulations require banks to have up-to-date opinions like this for every jurisdiction in which they trade, for every type of counterparty, and every type of master agreement.
Having, like many of you, lived with this exact problem for years, and having, for a sales & trading lawyer, an unusually low boredom threshold — I am “constructively lazy” — In my tours of duty I spent a lot of time trying to work out how to make this job less of an imposition.
This isn’t simply a problem of tedium. It is a real and present problem of cost. The world-wide collective enterprise devoted to gathering, wrangling, interpreting and applying these netting opinions is a full-blown military-industrial complex. Its total annual cost to the industry is hard to measure but surely runs to hundreds of millions, if not billions. That does not account for the psychological toll it takes on the thousands of well-meaning lawyers, treasury analysts, technologists and contract negotiators who are drawn into its slavering maw.
Now the financial markets owns some of the brightest and most creative structuring brains around. So why this problem hasn’t been solved before now?
That question has puzzled me. My own view is that there are myriad interlocking reasons.
To suffer is divine
For one thing, lawyers are a Calvinist bunch. There is nothing they like better than whipping themselves with cold spaghetti. There is a school of thought, widely held, that to suffer is divine: that if it isn’t painful, fiddly, counter-intuitive and complicated, it somehow can’t be any good for you. There is nothing more redolent of a devotional flogging than settling down with A Memorandum of Law on the Validity and Enforceability of Close-Out Netting under the ISDA Master Agreements under Italian law.
Amongst sales & trading lawyers this translates to the weary resignation that wading through pages and pages of an academic Belgian peroration on aleatory contracts is some how cleansing, noble, good and necessary. To suggest there might be a better way is seen as indicating weakness: a want of moral fibre or intellectual rigour.
Netting opinions are an inhouse lawyer’s cold-water swimming regime, therefore. As hateful as they may find them, it just isn’t done to complain.
Somebody else’s problem
For another, a bank’s “netting problem” is dispersed laterally across a number of back-office and risk management siloes: treasury owns the capital adequacy calculation. Trading pays for its balance sheet usage. Credit sets lines against individual counterparties. The documentation unit negotiates the contracts that give effect to the credit department’s policies. The legal department reviews and interprets the opinions. Each of them will see the overall problem — the “netting problem” writ large — as somebody else’s.
A “Somebody Else’s Problem” field, or ““S.E.P.”, is a cheap, easy, and staggeringly useful way of safely protecting something from unwanted eyes. It can run almost indefinitely on a torch battery, because it utilises a person’s natural tendency to ignore things they don’t easily accept. Any object around which an S.E.P. is applied will cease to be noticed, because any problems one may have understanding it (and therefore accepting its existence) become somebody else’s. An object becomes not so much invisible as unnoticed.”
The internal costs of the netting problem are similarly spread: industry association memberships are managed centrally and at an unfeasibly senior level. The portion of membership dues that goes on accessing industry association opinions is not broken out. Subscription to netting analytics services may be paid for by legal or credit but recharged to the business. Bespoke opinions are often paid for, somewhat arbitrarily, by the desks that first require them.
The human capital cost of all this busywork — making sure these layers of immortal & invisible protection are in place — is dispersed across various back-office risk teams and recharged to multiple front office trading desks.
The netting problem has no single owner. It is a classic “somebody else’s problem”.
Is it a problem?
The oddest thing about the netting problem is that, in practical fact, it doesn’t seem to be a problem. In the forty-five years since IBM and the World Bank executed that first ever swap, there has not been a well-known case of a receiver in a major financial centre challenging a close-out netting provision, let alone successfully.
To be sure, there have been near misses — famously, a German federal court narrowly construed the scope of contractual close-out in 2016, as chicken lickens like to remind everyone — but even that only threatened to limit and not strike down the single agreement concept. It did not happen. Germany’s regulators immediately amended the insolvency code to validate netting. Given the catastrophic effect such a ruling would have on a country’s own derivatives market, not to mention the stability of the wider financial system, the prospect of such an outcome happening in any other developed jurisdiction and being allowed to stand without corrective geopolitical action is, these days, unthinkable. Close-out netting is not a private commercial preference between counterparties. It is a systemic assumption of stable capital markets.
Naysayers might pick up that I said “developed” jurisdictions. “Aha,” they say, “but what about undeveloped jurisdictions?”
This is not the place to talk in detail about that yet: we’ll get into how banks can practically control that risk later — but note: the effect of designating a jurisdiction “no-net”, as much of sub-Saharan Africa and the Middle East is, is not just to allay the fanciful paranoias of the world’s bank regulators, but it is also to exclude a significant part of the the developing world from the international capital markets. And the international capital markets are exactly the sort of thing that could help them, well, develop.
Still, the received opinion seems to be that Basel rules requiring netting opinions are the very thing that has, single-handedly, spared the global financial system from the mendacious interventions of hostile receivers in far-flung places. Since you can’t presently trade swaps in Eritrea, we have been spared a live-fire experiment in the damage its insolvency regime could to the the banking system. That is why no-one has seen an Eritrean receiver pulling apart a master netting agreement. Maybe. But by the same token, no-one has ever seen elephants hiding upside-down in custard, either.
In the meantime, social justice warriors: if you really want to change the world, here is something to lobby about right away. Not glamorous, not interesting, not half as fun as painting yourself orange and gluing yourself to the floor, but it is important. Campaign against netting opinions!
Solving the problem
Q: How many therapists does it take the change a light-bulb?
The wounded pigeon flapping about in JC’s head was a technological solution to this sorry state of affairs. It is still somewhat complicated, and still involves lots of legal opinions, and it is true there are several even easier solutions — such as just doing away with the regulatory requirement altogether, or having the Basel Committee centralise and promulgate the netting requirements themselves, since they are the ones insisting on the requirement — but since none of these solutions are likely to happen in my lifetime, I invoke serenity’s prayer and present my one, that might.
The concept behind it is simple, but it requires three things to come together.
First, some fairly sophisticated — but not, in 2026, particularly revolutionary or even difficult — technology.
Second, a good understanding of how close-out netting works, the capital adequacy issue it addresses, how rogue insolvency administrators might upset it, what regulators expect to prevent that, how banks practically address that issue, how lawyers think about that issue, why the two don’t very well match, and how, with more thoughtful deployment of technology and a bit more assertiveness with the lawyers, the network might solve some of these problems. This bit I thought I could work my way through.
Third, people in the industry — financial institutions, industry associations, law firms, and their respective decision-makers and operations staff — would have to buy into this new way of doing things. They would have to be prepared to look differently at the world to see the opportunity presented by fixing this problem. The industry “light-bulb” — and all its little siloes, fiefdoms and power bases — would really have to want to change.
Experience tells me that, as a rule, those commanding prevailing siloes, fiefdoms and power bases do not want anything to change. Why would they?
The key, I think, is to find some participants in the system who do not have siloes, fiefdoms or power bases, but who would perhaps quite like them, and give those participants an opportunity to change. If those people embrace change, they can put the rest of the system into such a discombobulated funk that the rest of its citizens — including those with siloes, fiefdoms or power bases — might feel no choice but to change too.
In that case, to hell with the fiefdoms.
Getting to work
In 2026, the first step is manageable. So is the second. As with all complex systems, the third one’s the charm. If those in the “netting industry” even see it as a problem, rather that just a consequence of their professional calling, they see it as an insoluble one, that will occupy them profitably, if not excitingly, for the rest of their career. To be a successful financial markets professional you must have an unusually high boredom threshold, so we should not be surprised about this.
This situational tolerance for pain explains how the present arrangement has settled down the way it has. Not because it best suits the regulatory goal — it doesn’t — but because it suits the interests of those embedded in the current melée. Principally, lawyers. (JC has a theory that the financial markets in their entirety can be seen as a kind of extended phenotype for big law, but that is a topic for another day).
I want to talk about how we might induce the lightbulb to want to change a bit later on: for now, let’s carry on with the overview. It brings together many of JC’s favourite subjects: systems theory, financial engineering, market history and mythology and legal practice management.
I’ve had a bash at writing this as a conventional newsletter, but it just wasn’t working. I missed a couple of deadlines trying to make it work, so I’m going to try to make this into a customised podcast designed from the ground up as an immersive audio experience. That way I can give full flight to my whims for pastiche, fantasy and outright fabrication — if this makes it more fun for me, it should make it more fun for you — and tell the story in multiple parts.
This introductory episode is designed to set the scene, and outline the forthcoming episodes, culminating in the JC’s own live-fire experiment in trying to disrupt this great military industrial complex, an experiment that is doomed to fail.
If it fails, let it at least be an entertaining calamity. If it succeeds, so much the better, and we can save the world, emancipate the enslavèd hordes of inhouse lawyers around the planet and conclude this podcast from my new superyacht in the Mediterranean. I hear it’s nice of the north coast of Sicily at this time of year.4
If you haven’t, you should check out the late Tony Buzan’s books on mind maps.
A direct descendant, as it happens, of the famous contralto Gräfin Schümli Pflümli, and a man of some literary note. Not only did he feature in Barkley’s “Close-out! Close-out! Close-out!”, he was also the subject of Otto Büchstein’s opera Ogfried, the third in the Form und Substanz cycle.
This is a real-life example from the May 2017 opinion, now superseded.
Too soon?
