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Latest revision as of 03:14, 10 August 2023
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2002 ISDA Equity Derivatives Definitions A Jolly Contrarian owner’s manual™
5 in all its glory
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Overview
Article 5 General Terms Relating to Equity Swap Transactions
Section 5.1. Equity Amount Payer
Section 5.2. Equity Amount Receiver
Section 5.3. Initial Exchange Amount
Section 5.4. Initial Exchange Date
Section 5.5. Final Exchange Amount
Section 5.6. Final Exchange Date
Section 5.7. Rate of Return
Section 5.8. Initial Price
Section 5.9. Final Price
Section 5.10. Equity Notional Reset
Summary
Equity Amount Payer: Not of itself a wildly interesting definition but the question of when one is an Equity Amount Payer — when you are long, and not when you are short — is not entirely intuitive. The Equity Amount Payer is the equivalent of a “Seller” in an Option Transaction. The person paying away the equity performance. If the customer is long, the swap dealer. If the customer is short, the customer.
Equity Amount Receiver: Used in the context of Price Return Transactions, where the amount is payable by the Equity Amount Payer of the equity or index performance is positive, but (its absolute value) payable by the Equity Amount Receiver is the price return is negative.
Final Exchange Amount: In a delta-one Equity Swap Transaction, there is unlikely to be one. Maybe if the swap has a cross-currency element you might exchange notional amounts, or if it is some kind of par-asset swap.
Rate of Return: Used in calculating the Equity Amount, which is the amount you pay our on a Cash Settlement Payment Date.
Initial Price: Used in Rate of Return, which in turn is used in Equity Amount, and also very relevant to the Equity Notional Reset process. The Initial Price is different to the Equity Notional Amount in that it is expressed as a price per Share, whereas the Equity Notional Amount tends to be Initial Price * Number of Shares.
Note there is an initial Initial Price — the strike price in the Confirmation — but it is reset on every Valuation Date to the Final Price on that date — so the prevailing Initial Price fluctuates over time.
The way the Initial Price definition is drafted, you don’t need to say “... subject to adjustment on each Valuation Date” in the Confirmation, although for many of you this is sure to prove an irresistible temptation.
Final Price: Note that Final Price isn’t necessary the final Final Price: you determine a fresh Final Price on every Valuation Date, as of the Valuation Time, and they feed into the Cash Settlement (or Equity Notional Reset) process, whereby one party pays out the movement price of the underlier over the period since the last Valuation Date.
Thus, Final Price for today’s Valuation Date becomes the Initial Price for the next Valuation Date, and so on and so on — yesterday’s rooster is today’s feather duster so to say.
Only on the final Final Price does the Transaction terminate and that contingency — you know, calling it quits and wrapping the whole thing up — isn’t addressed in any particular way in the definitions booklet, the presumption being that you will just follow the same procedure as you would for any other Valuation Date on the last one. This might give your US Tax guy the heebie-jeebies, be warned, as he will want VWAP, or some kind of hypothetical broker dealer referenced in the very last one. Dash cold water in his face if so, and tell him to get it together, man.
Final Price in Synthetic prime brokerage
Where you are doing synthetic equity swaps, the Final Price on the Termination Date — the very one which gives your tax guy the heebie-jeebies — is mainly of academic interest, as it will only be a jowl-slappingly fortuitous coincidence if a client happens to go off risk at exactly the scheduled Termination Date.
In fact, a synthetic equity swap is an indefinite arrangement — it is replicating cash prime brokerage, remember, where a fellow holds (or shorts) a security at her own pleasure, so to speak — so the client can terminate at any time, and if it doesn’t terminate by the scheduled Termination Date she will typically want to roll the position (if she can[1]) without realising a gain or loss. Thus the Termination Date is fairly arbitrary, existing really only to avoid syntax errors in a booking system which will insist on you inputting one, or to resolve the unspoken anguish of your financial reporting folk who may otherwise fear you have an undated exposure to the underlying security[2].
Equity Notional Reset: The Equity Notional Reset is a feature for automatically restriking the Equity Notional Amount on a periodic basis to its prevailing value. It has the effect of converting posted collateral — which for financial institutions may suffer a punitive capital treatment — into realised profit and loss; and therefore no longer contingent liabilities to pay cash amounts.
Am equity swap will reset automatically on each Cash Settlement Payment Date, (i.e., usually a Settlement Cycle after each Valuation Date).
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- The JC’s famous Nutshell™ summary of this clause
- On the difference between Final Price and Relevant Price
- VWAP adjustments to Final Price for US Shares
- How Equity Notional Reset works
See also
- Equity Notional Amount
- Equity Notional Reset, the process by which your trade is re-struck on each Valuation Date.
- Volume Weighted Average Price (VWAP)
- Relevant Price
References
- ↑ There are complicated US Tax rules at play here
- ↑ Not, in fact true, as the broker-dealer will almost certainly have a right to terminate on (a month or more’s) notice, but do not expect this to placate a financial controller.