Template:M intro isda a swap as a loan: Difference between revisions

{{smallcaps|[[a swap as a loan|During]] a typically}} [[The bilaterality, or not, of the ISDA|turgid disquisition]] about the ostensible “bilaterality” of the {{isdama}}, the JC remarked rashly that despite ''looking like'' a bilateral, even-stevens, un-[[loansome]] sort of a thing, in practical fact most swaps are ''implied financing arrangements''.

Hotly justifying this stance sidetracked the original article, so we have “[[Let’s take it offline|taken things offline]]” and started a whole new article where the JC can properly make a tit of himself without spoiling a perfectly pointless ululation about [[The bilaterality, or not, of the ISDA|Party A and Party B]].

{{Quote|Whereas most finance contracts imply dominance and subservience — a ''lender'' who extracts excruciating covenants, takes mortgages, sharpens knives and so on, and a ''borrower'' whose mortal soul is traduced, suffers repeated indignities but who must yet feign affection through gritted teeth and deep resentment — swaps are ''not like that''.

“A swap contract is an exchange among peers. It is an equal-opportunity, biblically righteous compact between equals. There is no lender or borrower: each participant is an honest rival for the favour of the Lady Fortune, however capricious may she be.”}}

So here goes: the [[Jolly Contrarian|JC]]’s argument is that, outside the inter-dealer community, this conventional wisdom is not meaningfully true: an “end user” swap ''is'', in fact, a synthetic loan from dealer to customer. Furthermore, to the extent dealers are obliged to post two-way variation margin, ''regulators have made a category error in not realising this''.

Industry veterans may look upon you slack-jawed if you say this. Regulators certainly will. Being optimistic, they try to give you the benefit of the doubt for this flight of fancy, while thinking “''has the old bugger finally lost his marbles''?”

{{smallcaps|But this is}} not what the JC means. He means to say, economically, a dealer lends, outright, to a customer. One way.  

Now, far out in space, beyond the Oort cloud of the cramped star system of inter-dealer relationships, there is a boundless universe of “end user” swaps. Here, one party is a “dealer” and the other — the “end user” — is a “customer”. This is the great majority of all swap arrangements in the known universe. Hence, the expressions “[[sell side|sell-side]]” — the dealers — and “[[buy side|buy-side]]” — their customers.  

The difference between ''customer'' and ''dealer'' is not who is “long” and who “short” — one of the great [[Swappist Oath|swappist]] beauties is that customers can go long ''or'' short, as they please — nor on who pays “fixed” and who “floating”.   

For a ''customer'' the object of any transaction is to ''change its overall market exposure'': to leg into positions it did not have before, or leg out of ones it did. This sounds obvious enough. But dealers do ''not''. They say flat.  

“Hang on, though, JC: you yourself say a swap is a bilateral contract. How can that be so? Does it not follow that if the ''customer'' changes its position one way, the dealer must be doing so the other way?”  

Well, ''no''.  

The dealer ''provides'' exposure without taking any itself. It thereby earns a [[commission]]. This is all the excitement the dealer wants. The dealer hedges the market risk of the customer’s trade — which, yes, is the opposite to the customer’s position — away. Without no market risk, the dealer has only customer ''credit'' exposure.  

''As it would have'' ''in a loan''. (Spoiler: the similarities don’t end there.)