Template:M intro isda Party A and Party B

In this episode of the JC’s series of unfeasibly deep explorations of superficially odd things in the ISDA metaverse, consider the bilateral nature of the ISDA Master Agreement and its curious designators: “Party A” and “Party B”, and that curious descriptor of both of them: “counterparty”.

These set the ISDA apart; give it a sort of otherwordly aloofness. Other banking and broking transactions use labels which help you orient who is who: a loan has “Borrower” and “Lender”, or “Bank” and “Client”. A brokerage has “Broker” and “Customer”. A sale and purchase “Buyer” and “Seller”.

But not the ISDA Master Agreement. From the outside its framers — the First Men — opted for the more gnomic terms “Party A” and “Party B”.

Why? We learn it from our first encounter of an ISDA Schedule. Bilaterality.

Bilaterality

A belief in even-handedness gripped the ones whose deep magic forged the runes from which the First Swap was born.

For most finance contracts imply some sort of dominance and subservience: a large institutional “have” indulging a small commercial “have-not” with debt finance for the repayment of which the larger “have” enjoys a privileged place in the queue for repayment among the have-not’s many scrapping creditors.

But swaps, as the First Men saw them, are not like that.

“A swap contract,” they intoned, “is an exchange among peers. It is an equal-opportunity sort of thing; Biblically righteous in that, under its awnings, one be neither lender nor borrower, but an honest rival for the favour of the Lady Fortune, however capricious may she be.

“We are equals. Rivals. Counterparties”.

And, to be sure, swaps are different from loans and brokerage arrangements. They start off “at market” where all is square. Either party may be long or short, fixed or floating. At the moment the trade is struck, the world infused with glorious possibility. One’s fortunes may rise or fall relative to the other fellow’s and, as a result, one may owe (“out-of-the-money”) or be owed (“in-the-money”).

Now the ISDA Master Agreement itself never uses the terms “Party A” or “Party B”. Being genuinely bilateral, it never has to. The labels are arbitrary assignations that apply at trade level. Thus, they only appear in the Schedule and in Confirmations, to be clear who is who on a given trade: who pays the fixed rate and who the floating; which thresholds, maxima, minima, covenants, details, agents and terms apply to which counterparty. This much is necessarily different. Nothing beyond: the ISDA Master Agreement assumes you already know who is who, having agreed it in the Schedule.

So we agree: for this relationship we will call you “Party B”, and me “Party A”.

These colourless and generic terms hark from a time where, we presume, the idea of “find and replace all” in an electronic document seemed some kind of devilish black magic. Some kind of Tipp-Ex denying subterfuge.

But generic labels still lead to practical difficulties. A dealer with ten thousand counterparties in its portfolio wants to be “Party A” every time, just for peace of mind and literary continuity when perusing its collection of Schedules, as we know dealers on occasion to do. If, here and there, it must be “Party B”, it can lead to anxious moments should one misread such a Schedule and infer its infinite IM Threshold applies to the other guy, when really, as it ought, it applies to you. You quickly get over frights like this when you realise the error in your comprehension, not the negotiator’s articulation. Frights like this are, in their way, quite energising.

Less energising are actual errors: negotiators are redoubtable, admirable creatures but like all of us fallible, and prone to forget: they may, by lowly force of habit, forget to invert the “Party” labels when inserting your boilerplate PPF Event rider for that one time in a thousand when you are not “Party A”. It is easily done, and just the sort of thing a four-eyes check will also miss: If it does, no-one will never know — unless and until it is too late.

Is it bilateral though?

But there is a better objection: for all our automatic protestations to the contrary, the ISDA is not really a bilateral contract, and it is often financing contract.

We should not let ourselves forget: beyond the cramped star system of interdealer relationships, there is a boundless universe where one is a “dealer” and the other a “customer”. These roles are different. They do not depend on who is long and who is short. It behoves us not to forget.

In recent years — ironically, just as the “dealer” vs “customer” dynamic has become more pronounced — the global regulatory approach, still fighting last decade’s war, has kidded itself to the contrary.