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 seemed some kind of devilish black magic.

But generic labels still lead to practical difficulties. A dealer with ten thousand counterparties in its portfolio wants to be Party A every time. If, on occasion, it cannot be, this can lead to anxious moments should the legal eagles misread the confirms for those rare occasions where it is not.

Negotiators, too, are prone to forget. This is just the sort of thing a four-eyes check will miss: when dropping in your PPF Event template rider for that one time in a thousand when you are not Party A, it is easy to forget to invert the labels. If you do forget, no-one will never know — unless and until it is way too late.

But there is a better objection: for all our automatic protestations to the contrary, the ISDA is not a bilateral contract, and it is a financing contract. We should not let ourselves forget: beyond the comparatively rare interdealer universe, there will be a “dealer” and there will be a “customer”. Their roles are different, not depending on who is long and who is short, and 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.