How losses work

Trade finance loses money sometimes. A counterparty pays late, pays part, or does not pay. This page explains exactly what SukukDAO does when that happens to a tranche.

The rules in one paragraph: a loss stays inside its tranche. The part of it that falls on capital whose Sukuks were locked is borne by those Sukuks and by the responsible Agency's stake, side by side, in proportion. Their SUKUK is burned at backing per token. The part that falls on capital whose locks had ended, and anything the burns cannot cover, falls on backing, which every holder shares. Later recoveries refill the tranche before anyone is paid a fee or a credit again.

A missed payment

Each tranche has a next payment date, kept up to date by the payment feed. When the vault pays, the feed moves the tranche to its next date. When a payment is missed, the feed marks it on the day. A tranche guardian can also mark it. Both are set by the Safe, and the Safe can replace either through the protected path. The Agency cannot mark or unmark a missed payment.

A missed payment makes the tranche impaired. From that moment:

• exits, claims, Syndicate moves and re-allocation in that tranche are frozen;
• every seat and Agency sale in the protocol is frozen;
• any insider exit waiting on that tranche is cancelled;
• profit the vault pays is not distributed as fees or buybacks until the loss is recorded;
• genesis migration claims are paused.

An impairment is a pause, not a loss. Only the Safe can lift it, and when it does the tranche returns to the state it was in. An impaired tranche stays impaired until the Safe clears it, even if every dollar of principal comes back.

Recording a loss

A loss is recorded when the Safe starts it. Like every Safe action, this is queued in public for 7 days and needs 5 signatures, 2 of them from independents. The loss names the tranche, the amount and the period over which it built up. One loss can be open at a time, and a loss can never be larger than the principal still outstanding.

When the loss starts:

1. backing per token is recorded, as it stood before the loss;
2. the tranche is written down by the whole loss, which reduces backing;
3. each Syndicate's share of the loss is recorded as a deficit against the Agency that manages its capital.

After that, anyone can run the rest: weigh every Sukuk in the tranche once, then burn each one's share once, in batches. The last burn settles the Agencies.

Who bears it, and in what order

The loss is first divided by whether the capital was locked.

Capital whose locks had ended. Once a Sukuk's lock ends, its share of the tranche belongs to all holders. Its share of a loss falls on backing through the write-down, and every holder bears it through a lower backing per token.

Capital locked during the loss period. This share is borne by the tranche's locked Sukuks and by its Agencies, pari passu. There is no first-loss layer. Each side's weight is its dollars at risk over the period:

• a Sukuk weighs its principal times the time it was locked inside the period. A Sukuk that exited before carries nothing. A Sukuk bought after the loss started carries nothing;
• an Agency weighs its stake value times the share of all its capital that sat in this tranche at the start of the period, times the length of the period. Capital it took on later does not thin its share.

Whatever is left. If a Sukuk does not hold enough unreleased SUKUK to cover its share, the rest is recorded as the loss's shortfall. The shortfall falls on backing.

A loss in one tranche never changes another tranche's positions, deficits or credits.

Burns at backing per token

Each Sukuk's share of the loss, in dollars, is converted to SUKUK at backing per token as it stood before the loss, and that much is burned from the Sukuk's unreleased SUKUK. Credits are not touched. The bonus shrinks in proportion. The Agency's share is burned from its stake the same way, up to its slice.

Burning at backing per token keeps every other holder's backing per token where it was. The cost is that while backing per token is far below the price a Member paid, a modest loss burns a large part of a Sukuk. The share of a Sukuk that a loss burns is:

(your share of the loss / your principal) x (the price you paid per SUKUK / backing per token)

For illustration only. A tranche of $1,000,000 records a $100,000 loss. Every Sukuk was locked for the whole period. The Agency's stake slice is worth $50,000. The Sukuks carry $1,000,000 of weight and the Agency $50,000, so the Sukuks bear $95,238 and the Agency $4,762.

You hold a Sukuk with $10,000 of principal, bought at $0.235 per SUKUK: about 42,553 SUKUK. Your share of the loss is $952.

While backing is a small fraction of the price, a 10% loss in a tranche can burn 90% or more of a Sukuk. This was a deliberate choice. Burning at the 4-hour average price instead was considered and rejected, because fewer SUKUK would burn and the rest of the loss would move onto every other holder.

Recoveries

Money recovered after a loss, from a redemption, a later payment or a recovery the Safe records, goes first to refilling the tranche's write-down, before any Agency fee, credit or buyback. A recovery also earns back the Syndicates' deficits in proportion, so their high-water marks recover with it. A write-down is never kept above the principal still outstanding.

A recovery refills the reserve. It does not give burned SUKUK back. If a loss burns your Sukuk and the money is later recovered in full, the recovery raises backing for all holders; your burned SUKUK stays burned.

Write-offs

When the vault holds no more of the tranche's shares or requests and the recorded write-down covers everything still outstanding, the tranche is closed out. It closes when the Safe clears its impairment. The Agency's liability tail for that tranche then ends.

If a loss shows that an Agency's earlier fee was not earned, the Safe can send the held-back part of that fee to the reserve.

Who decides

The Agency does not decide whether its own tranche is impaired. The payment feed and the guardian mark missed payments. The Safe records losses and lifts impairments, through a public queue, with independent signatures. Anyone can run the weighing and burning once a loss has started, so a loss cannot be left half applied.