Lesson 13 of 25 · 6 min

What discretion means in the agreement

Not a mood but a defined power, granted clause by clause, with no obligation on the holder to explain itself.

In ordinary speech discretion means leeway. In a credit agreement it means something narrower and harder: a specific power, granted in a specific clause, exercisable without the other party's consent.

The powers that recur, each sitting in its own clause:

To determine the collateral value of any pledged asset.
To set and to revise advance rates, including to zero.
To deem a holding ineligible.
To decline a request to draw, even inside the stated limit.
To demand repayment of the whole balance.
To choose which assets are sold, and in what order.

Two features are common to all of them. The power is exercisable without agreement at the moment of use, because the agreement was given once at signing. And the power is bounded by the words of its own clause rather than by any general sense of fairness: a clause permitting revision of advance rates does not permit anything else, and a clause requiring notice for one act does not import notice into another. The absence of a clause is therefore as informative as its presence, since a power not granted is not implied by the breadth of the ones beside it.

Seen from inside, this is not aggression. It is the mechanism that makes the loan cheap, as Track 1 lesson 2 set out: the lender's recovery is fast because it does not have to ask. But the arithmetic of any one exercise is indistinguishable from a market event, and that is what makes discretion worth measuring rather than resenting.

Key terms

Discretionary power: A right the agreement gives the lender to act unilaterally on a stated matter. Consent was given once, at signing, and is not sought again.
Scope of a clause: The precise acts a discretion clause permits. Powers do not generalise across clauses, and neither do the protections attached to them.
Collateral shortfall: A balance exceeding lending value. It can arise from a price fall or from a revised advance rate, and the two look identical on the account.

Worked example

One clause, measured in market terms

A $704,000 pledged position at a 65 percent advance rate, against a balance of $362,000. The lender revises the row to 40 percent.

Lending value before: $457,600
Unused capacity before: $95,600
Lending value after: $281,600
Collateral shortfall after: $80,400
Price fall that would have done the same at 65%: 20.9%

One line in a policy document produced what a 20.9 percent market decline would have produced. Nothing was bought, sold or announced.

Check yourself

A $418,000 position carries a 70 percent advance rate against a $244,000 balance. The lender revises the row to 52 percent. What is the shortfall, and what price decline would have produced the same result at the original rate?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.