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CEOs Ask:
How can a funding TRS facility avoid losses resulting from balance sheet derecognition of illiquid collateral?
Discover how SITUASYS enabled funding for illiquid assets without incurring losses from balance sheet derecognition:

Avoid losses by overcoming the market standard

The treasury desk of a liquidity seeking corporation sought funding by using bonds on its balance sheet as collateral, which had lost substantial value and were partly also illiquid. It was paramount that the liquidity transaction would not lead to balance sheet derecognition of the bonds and thereby to losses. There was no alternative to a specific counterpart as liquidity provider in return for the illiquid collateral at hand.

The negotiations started with a conundrum and big gap between the parties. While the potential liquidity provider was not open to a portfolio repo, it offered instead to conclude a funding TRS facility. It insisted on cash settlement at market price at the end of the TRS facility, which is the market standard for the TRS [1]. It pointed to the illiquid nature of the collateral, its rehypothecation and the ensuing uncertainty as to whether it would be possible to return all the bonds to the liquidity receiver at the end of the facility.


Therefore, it demanded the market standard of cash settlement at market price. This would however result in balance sheet derecognition of the bonds, and thus go against the clear trade objective the liquidity seeker had set for itself. Such derecognition was actually common for basket TRS [2]. Thus, the liquidity seeker was facing the market standard objection “cash settlement”, with ensuing balance sheet derecognition, while seeking to obtain important liquidity from the only potential trade partner for the bonds at hand.





Innovator's View yields alternative TRS standards​

By adopting the Innovator’s View, I could persuade the potential liquidity provider to abandon the cash settlement market standard for TRS facilities and agree to a bespoke settlement mechanism instead, which turned the market standard into the least likely case to occur at termination. Instead, it had become highly likely that the bonds serving as collateral would be returned physically at the end of the funding. Physical settlement at market price had become the most likely scenario and the standard for this transaction.

What if all efforts by the liquidity provider to return the bonds at the end of the trade would fail? Even then, there was a way to protect the liquidity receiver from losses: Cash settlement in such case would occur at the higher of (i) the current market price and (b) the current book value of the bonds, plus (in case of costs) or minus (in case of gains) mark-to-market payments for the early termination of hedging transactions entered into by the liquidity receiver with regard to the relevant bonds. Upon request, it would provide written certification by its auditors of these mark-to-market payments.


As a result, losses would be avoided even in the absence of physical settlement and this is what mattered to the liquidity receiver. Here too, adopting the Innovator’s View brought about an alternative standard scenario in case of cash settlement of the relevant reference obligation.


  1. “Options, futures, and other derivatives”; John C. Hull, University of Toronto, 9th edition, p.582. “Alternative asset-based fund financing transactions”, Fabien Carruzzo and Dan King. Available at

  2. “Synthetic Funding Structures: The Art of Complex Trades”, Moorad Choudhry, in GARP Risk Review magazine, November/December 2004, Issue 21

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