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Derivatives Closeout Valuation · ISDA Documentation · Counterparty Representation · Expert Testimony
OVERVIEW
When Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy on September 15, 2008 — the largest bankruptcy filing in U.S. history — it left thousands of open OTC derivatives contracts across its global dealer network and claims against the estate that ran into the tens of billions. The questions that followed were among the most contested in derivatives market history: How should counterparties close out their positions? What methodologies were permissible under the 1992 and 2002 ISDA Master Agreements? How should illiquid and distressed instruments be valued in a market under severe stress?
Capital Market Risk Advisors (CMRA) was engaged at the center of this crisis., advising almost two dozen Lehman counterparties on valuations and close-out procedures. With Leslie Rahl having served on ISDA's founding board and chaired its first Documentation Committee, and with decades of combined experience structuring, trading, and risk-managing the precise instruments in dispute, CMRA was uniquely positioned to advise counterparties on their rights, expose valuation overreaches, and — where necessary — provide expert testimony.
CMRA represented almost two dozen Lehman counterparties — including hedge funds, sovereign-linked entities, major financial institutions, and Lehman Brothers International (Europe) itself as debtor — across a range of disputes spanning bilateral closeout negotiations, expert advisory engagements, and formal litigation. Almost all the matters were settled successfully without trial.
SCOPE OF ENGAGEMENT
— Shortly after the bankruptcy, CMRA was involved in a large initial claim that led to the formation of the Lehman Framework which was successfully used to resolve many other Lehman-related disputes in which CMRA was involved.
— The matters CMRA was involved with varied from ones with hundreds of thousands of derivative contracts to a dispute involving a single extraordinarily large derivative.
— CMRA represented counterparties in more than 18 separate Lehman-related disputes, spanning bilateral negotiations, pre-litigation advisory, mediation and formal expert witness engagements
— Clients included hedge funds, European and Asian financial institutions, a Japanese bank holding CDS on Icelandic reference entities with Lehman as counterparty, and Lehman Brothers International (Europe) (LBIE) as debtor
— Advised on closeout valuation methodology under both the 1992 and 2002 ISDA Master Agreements, including the Loss, Market Quotation, and Close-out Amount methods
— Provided strategic and analytical support across instruments including interest rate swaps, credit default swaps, equity derivatives, FX derivatives, total return swaps, and structured products
— Retained as testifying expert in QVT vs LBHI, a dispute over valuations of largely Lehman-proprietary derivatives
— Retained as testifying expert in LBIE v. AG Financial Products — a twelve-year dispute over ISDA Loss method valuation of CDS on ABX, CDO, and CLO instruments (see case detail below)
CMRA was involved in resolving derivatives disputes in corporate CDS, FX, including cross rate derivatives, CDOs, CLOs, Subprime MBS as well as proprietary Lehman products such as CDS on preferred stock.
Some of the derivatives in question had no viable market after the Lehman bankruptcy and valuations had to be imputed based on the costs of hedging the instruments or based on customized algorithms.
Notable examples of challenging valuations included
· A very large binary options on the slope of the yield curve,
· Icelandic Bank CDS when trading in their debt and CDS had virtually or completely ended due to credit concerns,
· AUD/JPY cross exchange rate embedded in retail derivative products when that cross rate declined by 40% as carry-trade-based derivatives had to be unwound.
· Proprietary Lehman preferred stock CDS.
REPRESENTATIVE CLIENTS AND MATTERS
Japanese Bank — CDS on Icelandic Banks
CMRA was retained by a Japanese financial institution that held credit default swaps referencing Icelandic banks, with Lehman Brothers as the counterparty. When Lehman filed for bankruptcy in September 2008 — itself occurring days before the collapse of the Icelandic banking system in October 2008 — the client faced the challenge of closing out its CDS positions with the Lehman estate at a moment of acute and compounding market dislocation. The engagement required analysis of closeout valuation methodology for CDS referencing credits that were themselves in or near distress, under conditions where market data was severely impaired and the commercial reasonableness of any calculation was highly contestable.
Asian Bank — Binary Slope of the Yield Curve
CMRA was retained by an Asian financial institution to value a complex and extraordinarily large derivative that was practically untradeable and for which no market quotations were available. The valuation required calculating the costs to a counterparty to hedge the transaction using a bundle of options. CMRA represented the client in mediation. The matter was settled successfully.
QVT Financial — Hedge Fund Counterparty
CMRA advised QVT Financial, a major event-driven and credit-focused hedge fund, in connection with its derivatives closeout claims against the Lehman estate. The engagement involved analysis of closeout valuation methodology, review of Lehman's calculation statements, and assessment of the appropriate standard of commercial reasonableness under the applicable ISDA documentation.
Lehman Brothers International (Europe) (LBIE) — Debtor
CMRA was retained on behalf of LBIE itself, the principal European operating entity that entered administration on September 15, 2008 alongside the U.S. parent filing. LBIE faced hundreds of contested closeout calculations from its own counterparties and engaged CMRA to provide independent valuation analysis and expert-level review of those counterparty calculations.
Additional Counterparties: Canadian and European Banks and US Banks and Hedge Funds
CMRA was retained to provide exact calculations of Loss under the 1992 ISDA Master and the 2002 ISDA Master for many thousands of derivatives contracts using commercially reasonable methodologies to reach commercially reasonable results. In many cases, the Lehman Framework was used while in some cases customized approaches specific to the client could be adopted. Examples included:
· Hedge funds disputing closeout valuations on credit and equity derivative portfolios
· European financial institutions contesting Loss method calculations on interest rate and FX derivatives
· Asset managers challenging the valuation of structured product and TRS positions
· Asian financial institutions holding CDS on distressed reference entities, requiring independent review of Lehman closeout calculations in a seized market
CMRA'S ANALYTICAL EXPERTISE IN LEHMAN MATTERS
CMRA's Lehman work drew on the firm's unmatched combination of ISDA documentation expertise, derivatives valuation depth, and crisis-period market knowledge:
— Documentation expertise: ISDA Master Agreement interpretation
· 1987, 1992, and 2002 Master Agreements — all vintages active in Lehman's portfolio
· Loss vs. Market Quotation vs. Close-out Amount — methodology selection, application, and commercial reasonableness
· Early Termination and Netting provisions; Credit Support Annex collateral disputes
— Valuation methodology: Closeout valuation in distressed markets
· Establishing defensible mid-market values for illiquid instruments when dealer quotes were unavailable or unreliable
· ABX, CDX, and single-name CDS in a seized market; structured product (CDO, CLO) valuation under the Loss method
· Distinguishing commercially reasonable Loss calculations from opportunistic overreaches
— Crisis-period market knowledge: Contextual market expertise
· CMRA was active as risk advisor and expert during the 2008 crisis in real time — not reconstructing it post hoc
· Leslie Rahl's service on ISDA's founding board and as chair of its first Documentation Committee provides direct insight into drafting intent
· Peter Niculescu's management of the world's largest MBS and swaptions portfolio at Fannie Mae through periods of heightened market volatility gave real-time crisis management experience.
WHY CMRA FOR DERIVATIVES CLOSEOUT AND ISDA DISPUTES
“What Red Adair is to oil and gas exploration, CMRA is to financial engineering.”
— Grant's Interest Rate Observer
— CMRA has been involved in virtually every major derivatives market crisis since the firm's founding in the early 1990s — from Orange County and Sumitomo Copper through LTCM, Lehman, MF Global, and Volmageddon
— Our partners have managed over $150 billion in derivatives business and held direct responsibility over balance sheets totaling over $1 trillion
— Leslie Rahl served on ISDA's founding board for five years and chaired its first Documentation Committee — providing direct, non-reconstructed insight into ISDA documentation intent
— Peter Niculescu holds a Yale PhD and managed the world's largest MBS and swaptions portfolio at Fannie Mae — bringing rigorous quantitative credentials to structured product and options valuation disputes
— Experience Matters: CMRA's Lehman work was conducted in real time, beginning in September 2008 — not assembled retrospectively for litigation purposes