Regulation and Documentation

The Difference Between Cleared & Uncleared Documentation

Documentation for Uncleared Derivatives

Bilateral Derivatives: Swap Documentation will be:

  • The confirmation

Will be sent out by swap dealer, signed and returned by counterparty Confirm includes the economic terms of the trade Confirm can also include additional terms (i.e., mutual break clauses, etc.)

  • The ISDA Master Agreement

View the ISDA Documentation Center here Contains term common to all counterparties

  • Schedule A Is considered part of the ISDA MAster Agreement, where all unique terms agreed to between the counterparties are placed

Termination Provisions:

Specified Entities

Cross Default

Credit Even Upon Merger

Agreement to Deliver Documents

Certificates of Incorporation

Certificates of Incumbency

Board Resolutions — allowing the use of derivatives

Legal Opinion from corporate auditors

Security Pledges, Guarantees, etc. related to credit support

For example: if a counterparty had a bank loan and a swap, the bank would incorporate the securites agreement and the loan document into the ISDA so that a common set of default provisions would apply to the loan and the swap, and security would be available to support both exposures.

Other Provisions: Set-Off

Additional Terms for FX Transactions & Currency Options

  • The Standard Collateral Support Annex

The largest change is the Collateral Support Annex (CSA). Before, these were highly customized agreements reflecting the relative opinoins of the two institutions. Again, will depend on the country booking the swap, but will be a STANDARDIZED contract.

  •  SCSA (Standard Collateral Support Annex) here
    • The SCSA take the place of the CSA, changing several key elements:
    • Zero threshold and zero transfer minimum (aka mark-to-market daily)
    • Eliminate Collateral switch options
    • Align interest accruals on cash collateral
  • ISDA Master Agreement and Addendum A will remain part of the Documentation package for uncleared swaps
    • In the U.S.: this will be the Standard Collateral Support Annex (SCSA)
    • When a Bilateral Swap trades through a Swap Execution Facility (SEF) all trade details are automatically generated.
    • A reference number for each swap is created to identify each swap.  All other economic and legal terms of the swap are included in the confirmation.  Confirmations are sent eleectronically over a SSL, signed by an authorized signatory and returned to the respective counterparty.
    • You can learn all about SEF’s here
  • The GMRA (Repo Agreement) in order to post repo as collateral will be signed between the counterparty and the bank.
    • The purpose of the repo is to post collateral in a secured form.

Uncleared derivatives is still documented in a similar way as was done pre Dodd-Frank. The main differences were certain Standardizations.

The ISDA Master Agreement

The ISDA Master Agreement is an overarching contract covering all derivatives contracts with a customer. Even from the first iteration in 1992, most of the terms were standardized. Today in a post Dodd-Frank era The ISDA Master Agreement for Uncleared Derivatives is even more standardized that before.

Specified Entities

On that basis a Specified Entity is an affiliate of a counterparty which is covered by the Master Agreement for Cross Default in the event of bankruptcy or default of a subsidiary. The fifth Termination Event is called Credit Event Upon Merger (Section 5(b)(v) in 2002 ISDA Master Agreement).

The aim is to draw in those members of your counterparty’s group (such as its parent or asset rich fellow subsidiaries) whose relationship is so close to your counterparty that if an Event of Default happened to them it would be very likely to affect your counterparty seriously too.

A specified entity is one that is crucially important to the Parent Company or financially substantial companies to a Holding Company:

  • Sometimes these Specified Entities are specifically named and sometimes a general term “Affiliates” is used.
  •  “Affiliates” essentially means any other company in your counterparty’s group. Specified Entities can be proposed to apply to all the above sub-sections or just to Section 5(a)(v) (Default under Specified Transaction).

In all cases which Specified Entities apply to each party is a credit decision. Specified Entities is a way of collapsing down all transaction at once. This can provide an advantage to the customer who may have profitable swaps on one entity and losing swaps in another. Cross default may mean the counterparty doesn’t have to pay a loss it cannot afford.

Big companies are often able to negotiate that Specified Entities will not apply.

  • Smaller ones may be able to limit Specified Entities to Material Affiliates only. This would have to be defined but could cover those which account for, say, 15-20% of group pre-tax profits or assets.
  • Credit Support Providers are automatically included in these four Section 5 events and do not need to be named separately as Specified Entities for them.

While Specified Entities are not always needed, a counterparty which is a corporate holding company whose main financial substance of the corporate’s holding company is in those subsidiaries, the bank’s credit officer may want them as Specified Entities.

The Addendum A

The Addendum A includes very specific terms and conditions.

The Standard Collateral Support Annex (SCSA)

Another document which has become more standardized is the SCSA, which spells out the threshold level when collateral will be required. Today this includes:

  • Derivatives Risk: because it’s a leveraged product, the risk is always much greater than the notional amount of the contract. As time passes the derivatives line needed changes.
    • The amount of derivatives line required depends on the contracts years to maturity
    • The notional amount of the contract
    • The time difference between the pay leg and receive leg of the contract
      • i.e., A bank paying every quarter and receiving every six months has more counterparty credit risk than a contract where the bank is receiving quarterly and paying semi-annually.

The Standard Initial Margin Method (SIMM)

The SIMM codified uncleared derivative contracts and made them all more standard so as to place all counterparties on the same level.

Documentation for Cleared Derivatives

All swaps executed on SEF are cleared at a CCP. Typically the SEF affirmed the transaction with both counterparties then onboarded to the Clearinghouse. However, the costs incurred by the dealer will depend on how many brokers are between the end user and the clearinghouse. You can read more about these relative costs here »

Cleared Derivatives: Swap Documentation will be

  • Clearing Agreement Futures Agreement  w/ OTC Addendum

Agreement between clearinghouse and clearing member

  • Give-up Agreement

Agreement between final client and clearing member firm Covers execution and clearing member “agency” submission of swaps

  • There may be collateral agreements  between final client and clearing member firm

This short list gives you an overview of the types of documentation a buy-side firm would need with a swap dealer. Since then, ISDA has added a few documents:

RECOMMENDED COMMON PRINCIPLES FOR RELATIONSHIPS BETWEEN CUSTOMER AND EB AND CM (November 2009)

The principles are intended to facilitate negotiation of relevant agreements in the context of different clearing platforms.

FIA-ISDA CLEARED DERIVATIVES EXECUTION AGREEMENT

The Cleared Derivatives Execution Agreement is a template for use by cleared swaps market participants in negotiating execution-related agreements with counterparties to swaps that are intended to be cleared.

FIA-ISDA CLEARED DERIVATIVES ADDENDUM

The FIA-ISDA Cleared Derivatives Addendum is a template for use by cleared swaps market participants to document the relationship between a clearing member and its customer for purposes of clearing over-the-counter derivatives transactions (referred to as “Cleared Derivatives Transactions”).

FIA-ISDA CLEARED DERIVATIVES EXECUTION AGREEMENT – Version 1.1

(Version 1.1, published September 20, 2012, replaces Version 1)The Cleared Derivatives Execution Agreement is a template for use by cleared swaps market participants in negotiating execution-related agreements with counterparties to swaps that are intended to be cleared through U.S. Futures Commission Merchants. The Memorandum explains the changes between Version 1 and Version 1.1.

ISDA/FBF Annex to the Client Clearing Addendum

This Annex is a template for use by cleared swaps market participants with the ISDA/FOA Client Cleared OTC Derivatives Addendum where the underlying master agreement is an AFB/FBF Master Agreement. It includes a form of paragraph 11 to the ISDA 1995 Credit Support Annex that can be used with the Addendum where the underlying agreement is an ABF/FBF Master Agreement.

ISDA/FIA CLEARED DERIVATIVES EXECUTION AGREEMENT (EU principal-to-principal arrangements)

The non-US, English law Cleared Derivatives Execution Agreement is a template for use by market participants in negotiating execution-related agreements with counterparties to swaps that are intended to be cleared.

Swaps Documentation

Swaps Documenation is handled differently depending on how the contract is cleared.

Cleared Derivatives: Swap Documenation will be

  • Clearing Agreement Futures Agreement  w/ OTC Addendum

Agreement between clearinghouse and clearingmember

  • Give-up Agreement

Agreement between final client and clearing member firm Covers execution and submission of swaps

  • There may be collateral agreements between final client and clearing member firm