Template:Isda Preamble summ

Like all good stories, the ISDA starts with a {{ {{{1}}}|Preamble}}. Everyone, once, stares at that gnomic title and thinks, “okay, what the hell is this all about?”

Well, step this way, young padawan. Step into this rabbithole. Personal note: in Wellington, New Zealand, a chap called Gerald (if you’re reading, hi, Gerald!) asked a callow young contrarian to look have a look at this odd document that seemed to be called an Aïessdiyé once, in about 1995, and — well, here we all are, folks.

Honestly, if I had known how much time I was going to spend with the damn thing I would have paid a lot more attention to it in the first place.

A word on industry associations

Sell-side

ISDA, which publishes the ISDA, was the “International Swap Dealers Associations, Inc.” — interesting plural, that — but in any case, outwardly a sell-side industry association. Sometime between 1992 and 2002, it rebranded itself as the “International Swaps and Derivatives Association, Inc.”: singular, at the same time more unitary and more inclusive sounding, but still in spirit the same old ISDA, stake-held predominantly by the largest broker-dealers on the face of the Earth.

It may have aspirations to conquer the world — increasingly, it seems hell-bent on doing so, encroaching on the commodities, carbon, securities financing and crypto domains — but for now ISDA remains a “dealer-community” association, largely devoted to the swap.

Buy-side

These days the “buy-side lobby” is bigger, more organised and better represented than it used to be, with the following associations representing its interests:

AIMA (the Alternative Investment Management Association)
EFAMA (the European Fund and Asset Management Association)
The MFA (the Managed Funds Association) — not to be confused, by the way, with the Fund Management Association of Kenya — and
The AI (the Investment Association).

Buy-side and sell-side

We will have more to say about this in later essays, but for the time being note that in most swap transactions there is a “sell-side” dealer and a “buy-side” end user to an ISDA Master Agreement. There is, it is true, a small class of “inter-dealer” swap contracts, but these generally do not create quite the same excitement as do those between dealers and their customers.

“Dealer” versus “broker”

Swaps are inherently principal contracts, so the sell-side participant in a swap is always a “dealer”. (Brokers act as agents to put a buyer and a seller together and charge a commission. Dealers act as principal, buying from a seller, and on-selling to a buyer, but the economic upshot of what they do in either case is the same.)

Three important things to bear in mind about swap dealers:

1. They aspire to be market neutral: Typically dealers provide market exposure to customers without taking a market position themselves.
2. They delta-hedge: since a swap is inherently a principal-to-principal contract and not an agency arrangement, and entering does change the dealer’s market position, the dealer will execute offsetting delta-hedges in the market to “flatten out” its position. It has quite a lot of flexibility in how it does this.
3. Dealers are regulated: Because they are concentrated points of risk taken on by their customers, dealers are heavily regulated, both in terms of their conduct of business — with whom they can do business, and on what terms, and prudentially — in how they manage customer and market risk and how much capital they must hold. Some swap customers are regulated, in particular those who manage retail investment funds — but generally the regulation is there to protect the “ultimate client” a mythical grandpop who wants nothing more than to dandle his granddaughter on his knee while she blows upon a dandelion, and warm beams of sunshine bathe them all in holy light.

If dealers fail, it tends to be more or less apocalyptic for the market. But the market is getting better at managing the stress of dealer failures (Credit Suisse caused a lot less dislocation than did Lehman), and in truth dealers do not fail that often.

The preamble

The {{{{{1}}}|preamble}} is just the loosener before things get properly going, and there is not a lot to see. It has not changed a lot between the 1992 ISDA and the 2002 ISDA (nor indeed, from the 1987 ISDA, except that the Single Agreement clause got promoted from a casual remark during the warm-up, in the 1987 ISDA, to the first searching delivery of the first over.