Trading Strategy Indices – Third Party Calculation Agents

Third Party Calculation Agents

Third Party Calculation Agents have become more prevalent in the past years. Companies that run the strategy/index calculation as an outsourcing partner for the investment banks. This may not seem of great interest for the end client at first glance; however, there are some benefits to such an approach.

The calculation agent has very broad and discretionary powers. Banks that aim for a sustainable business will not abuse them, but there obviously is a conflict of interest. This excerpt is from the risk factors of an equity structured note.

If the calculation agent is the same entity as the guarantor and the issuer is an affiliate of the guarantor, potential conflicts of interest may exist between the calculation agent and the purchasers.

From a control point of view, it is an improvement to have an impartial third party involved calculating levels. It is true that the banks pay Third Party Calculation Agents, but this is a systematic process that can be verified, unlike CDO ratings for example.

The Third Party Calculation Agent can also provide some help/consulting on best practices for exception handling and some quality control for the rules to less experienced strategy providers.

In big and experienced investment banking operations, these advantages may not count for much, as they normally already follow best practices. Nevertheless, with the proliferation of smaller banks releasing Trading Strategy Indices, the potential for quality control as part of the work of Third Party Calculation Agents could grow.

For most clients, the existence of calculation agents other than the investment bank providing the investment strategy may not be significant enough to influence any investment decisions. Very sophisticated clients sometimes have to set up their own calculation spreadsheets, this could also be an area where Third Party Calculation Agents can leverage their knowledge and offer consulting services.

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