"A final point on recovery is related to the timing. CDSs are settled quickly following a default and bondholders can settle their bonds in the same process (the CDS auction) or simply sell them in the market. However, bilateral OTC derivatives cannot be settled in a timely manner. This is partly due to their bespoke nature and partly due to netting (and collateral), which means that many transactions are essentially aggregated into a single claim and cannot be traded individually. The net claim (less any collateral) is then often quite difficult to define for the portfolio of trades (see Figure 3.3 in Chapter 3). This creates two different recovery values:
In theory, settled and actual recoveries should be very similar, but in reality – since bankruptcy processes can take many years – they may differ materially. This is illustrated in Figure 12.5. It should be possible to agree on the claim with the bankruptcy administrators prior to the actual recovery, although this process may take many months. This would allow an institution to sell the claim and monetize the recovery value as early as possible. In the case of the Lehman Brothers bankruptcy, the settled recovery was around 9%, whereas some actual recoveries received since have been substantially higher (in the region of 30– 40%). It should also be noted that recoveries on derivatives may be improved due to offsetting against other claims or other assets held (e.g. see the discussion on set-off in Section 5.2.5). These components may not be priced into transactions (they are not consistent with the exit price concept applied to accounting CVA), but may give some additional benefit in a default workout process.
- Settled recovery. This is the recovery that could be achieved following the credit event by trading out of a claim; for example, by selling a defaulted bond.
- Actual recovery. This is the actual recovery received on a derivative following a bankruptcy or similar process.
-- Gregory, Jon. The xVA Challenge: Counterparty Credit Risk, Funding, Collateral, and Capital (The Wiley Finance Series) (pp. 274-275). Wiley. Kindle Edition."
