The ISDA (International Swaps and Derivatives Association) has, since 1985, provided the OTC industry with standardised documentation with which to work. A key aim of the ISDA has been to reduce legal and credit risk in OTC derivatives trading.
The importance of how the ISDA Master Agreement is understood, negotiated and implemented cannot therefore be underestimated. Getting the right agreement is absolutely essential to establishing an effective, safe and beneficial OTC trading relationship.
Tailoring the Agreement
The terms of the ISDA Master Agreement should be carefully tailored for each trading relationship as, once it’s finalised and signed, it governs all individual transactions between the two parties – past, present, and future.
Fundamental to the process is careful customization of the ISDA Master Agreement to take into account and ultimately reflect your organisation’s credit risk management philosophy. Examples of what might be at issue here are thresholds, cross default provisions, CSA, and possible defaults and potential remedies for them. There might well be other key points that need to be negotiated before the trading relationship is satisfactorily agreed.
It’s important to be aware that terms referred to as ‘standard’ – including conditions precedents, interpretation provisions, representation, undertakings, termination events, governing law, and early termination – can and should often be customised to suit each individual trading relationship. In that sense, there is nothing straightforwardly ‘standard’ about the agreement, which is why care needs to be taken when entering into any and all OTC trading relationships.
ISDA negotiators are centrally important in arranging agreements that regulate OTC derivative trades. The individual negotiators involved are the people who will customise the ISDA Master Agreement, taking into account the needs and philosophy of the organisation on whose behalf they are acting. Often parties will use more than one negotiator to reach agreement on terms.
Each ISDA negotiator will have a full and up-to-date knowledge of not just the two main ISDA Master Agreements (Multicurrency – cross border and Local currency single jurisdiction), but also the User’s Guides and related documents. This knowledge is essential to establishing an effective and beneficial trading relationship via an appropriately drafted agreement.
An ISDA negotiator should be an expert draftsman, with an appropriately skilled and experienced eye for detail, focus, and thoroughness in relation to the specific task at hand. A skilled negotiator should also be patient – helping to maximise the likelihood of achieving what she or he wants for your organisation. It’s also usual for ISDA negotiators to take a fundamentally conservative approach – not playing fast and loose with the needs and requirements of your organisation.
Crucially, your negotiator should also have a well-developed network of relationships, and be used to interacting regularly with parties such as fund managers, counterparty banks, and other negotiators in the industry. Confidence and a willingness to engage in face-to-face discussion rather than conducting business primarily by letter and email are often helpful indicators that a negotiator uses networks to their full advantage.
Getting the Best Deal
To best exploit trading opportunities in OTC markets, it’s crucially important to develop and make use of networks of relationships, usually via a negotiator who has precisely this ability. This is especially important in establishing an OTC trading relationship, because it is set up via a dealer network rather than a centralized Exchange.
Another important consideration arises from OTC derivatives being traded in this way, rather than through an Exchange: that is, each party’s concern with whether or not the counterparty can adhere to the trade agreement and avoid defaulting. A skilled ISDA negotiator should focus on this area, customising terms to address these concerns, and to cover all eventualities.
In essence, then, to start up an OTC trading relationship, it’s essential to recognise:
- The importance of the ISDA Master Agreement and its being tailored to your organisation’sneeds and philosophy
- The central role of ISDA negotiators to the process of customising the agreement in line with your organisation’s interests and preferences
- The significance of a network of relationships to establishing an effective and beneficial OTC trading relationship
This article is posted by James on behalf of :
Abigail Harding joined Derivatives Documentation Ltd in June 2008. She has 2 years’ credit derivatives confirmations and one year’s middle office experience in structured credit derivatives for a large American investment bank. Since joining DDL she has worked on a number of in-house and outsourced assignments relating to ISDA and CSA negotiation. She has also provided training on credit derivatives documentation.
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