What Is a Calculation Agent?
A calculation agent is an individual or entity that is responsible for determining the value of a derivative. A derivative is a financial security that derives its value from an underlying asset or benchmark. A calculation agent calculates the value of a derivative and the amount owing from each party. The calculation agent can also establish the price for a structured product and may act as its guarantor and issuer. If the counterparty in a derivative transaction is a broker-dealer, then they will often act as the calculation agent.
- The calculation agent, who can be the seller or a third party, calculates the value of a derivative and the amount owing from each party.
- The calculation agent also determines the final price, the currency rate if two different currencies are exchanged, and any accrued interest.
- The calculation agent facilitates the payments of the cash flows between the two parties and establishes the settlement date for the exchange.
Understanding a Calculation Agent
The calculation agent, who is typically either the seller or a third party, sometimes takes on a number of other roles in more complex transactions. This role includes deciding who owes what to whom in the transaction. However, there are other important responsibilities that a calculation agent is charged with, including:
- Determining the final price according to the agreed valuation method
- Determining the currency rate if two different currencies are exchanged as a result of the cash flow payments between the two parties
- Calculating the earned or accreted amounts as well as accrued interest
- Setting the current market value
- Establishing the number of business days for the settlement of the cash flows, such as two business days from the transaction trade date
- Any modifications or restructurings that are needed or were requested by the parties involved
- Acting in good faith and with reasonableness in getting the transaction completed as well as proper, timely notification or confirmation of the financial details to the parties
Companies, for example, that are due to receive floating or variable interest payments from a security might want fixed payments instead. They could exchange the variable-rate cash flows—via a swap—to a company that wants floating rate payments but has fixed-rate cash flows. A swap is the exchange of cash flows from one company or counterparty to another. The calculation agent would handle the cash flow payments and pricing as well as any necessary changes to the reference entity or the debt issuer.
The Importance of a Calculation Agent
An average investor will likely never interact directly with a calculation agent, as most derivatives accessible to retail investors are standardized and deal with liquid and largely transparent markets. In these cases, establishing the price mainly means looking at the publicly available market price. As the derivatives in question push into thinner markets or the nature of the transaction are customized away from market standards, the calculation agent grows in importance. However, the increased importance given to the determination of the calculation agent can result in a conflict of interest when the calculation agent is also the seller.
The calculation agent is also important in transactions that are netted. Companies might owe each other a stream of cash flow payments in a transaction. If one counterparty owes another counterparty more money, the calculation agent would determine the net difference owed by the first counterparty. In other words, instead of both counterparties transferring payments to each other, the counterparty that owed more would pay the net difference with the calculation agent facilitating the calculation, payment, and settlement date.
Disputes with a Calculation Agent
The calculation agent is not a fiduciary but is expected to avoid conflicts of interest and act in good faith. Any disagreement over the calculation agent's decisions must be resolved by a disinterested third-party dealer, usually suggested by the calculation agent following consultation over the dispute. The International Swaps and Derivatives Association (ISDA) has outlined a calculation dispute resolution procedure to guide counterparties through what can be a complex process.
With more exotic derivatives that have been customized for the client, the actual valuation may depend on a dealer’s internal models. This makes third-party dispute resolution more difficult, as some of the pricing information and techniques may be unique to that particular dealer. In these cases, third-party dealers can be polled to help establish an average based on the contractual design of the derivative. To make a determination of this nature, there needs to be a response by the set deadline from an agreed-upon minimum number of responders.