Underlier - Equity Derivatives Provision

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2002 ISDA Equity Derivatives Definitions

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Underlier in a Nutshell

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Section 1.13. Index. “Index” means, in respect of an Index Transaction or Index Basket Transaction, each index specified as such in the related Confirmation.

Section 1.14. Shares. “Shares” means, in respect of a Share Transaction or Share Basket Transaction, the shares or other securities specified as such in the related Confirmation.
Section 1.15. Basket. “Basket” means, in respect of an Index Basket Transaction, a basket composed of each Index specified in the related Confirmation in the relative proportions specified in the related Confirmation and, in respect of a Share Basket Transaction, a basket composed of Shares of each Issuer specified in the related Confirmation in the relative proportions or numbers of Shares of each Issuer specified in the related Confirmation.
Section 1.16. Issuer. “Issuer” means, in respect of Shares, the issuer of the relevant Shares.

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A JC-curated sub-division of the General Definitions section. We sub-group the Section 1 definitions into the following subgroups:

These are the Underliers:

1.13. Index
1.15. Basket
1.16. Issuer



Not, however much we might wish it were otherwise, a thing under the 2002 ISDA Equity Derivatives Definitions. Underlier”?: There isn’t a generic catch-all term for the underlier of an Equity Derivatives Transaction. This is a pity, since “Index, Share or Basket as the case may be” isn’t the most elegant expression in the annals of legal literature. You might have used “Instrument” or even “Underlier” might do.

Underlier” is a JC-spawned confection, and we do use it from time to time, when our patience with ISDA’s crack drafting squad™ and its leaden drafting becomes as shiny, thin and translucent as the seat of an old pair of suit trousers.


Dividends on Index Transactions? No, sir. But yes, sir.

We shouldn’t really need to say it, but we will: You don’t — well ~ cough ~ shouldn’t — get dividend payments on an Index Transaction. The Index calculation methodology will either replicate the effect of dividend reinvestment on Index constituents, by proportionately re-weighting constituents when they pay dividends — in which case you will get the effect of those dividends just through “price return” of the Index level — or it won’t, in which case you won’t get the effect of those dividends, BECAUSE YOU BOUGHT A DERIVATIVE OF AN INDEX THAT DOESN’T REPLICATE THE EFFECT OF ANY DIVIDENDS.[1]

Either way, the dividend provisions of the 2002 ISDA Equity Derivatives Definitions aren’t — well ~ cough ~ shouldn’t be — relevant to Index and Index Basket Swap Transactions. So they don’t really countenance the idea of an Index paying through dividends. While, in the Russian-doll defined terms schema confected by ISDA’s crack drafting squad™ an Index Swap Transaction is a kind of Equity Swap Transaction, and therefore can have a Type of Return applied to it, when you dive down the rabbit hole, through the Total Return star-gate, along the Re-investment of Dividends axis and into the Dividend Amount portal, you hit the hard black nothingness of dark energy: A Dividend Amount is defined, of course, by reference to a Share’s Record Amount, Ex Amount or Paid Amount, and not that of an Index, for the compellingly straightforward reason that Indices are abstract numbers. They don’t pay dividends.

Now ISDA’s crack drafting squad™ made a half-hearted swipe — actually, it a was more like a full-blooded, half-hour long drubbing — in one of the Pan-Asia MCAs to build in manufactured dividends to Japanese index products, but it is fiendishly complicated, not to mention wrong-headed, and no-one uses it as far as we know.


There is a fairly common market practice, for indices that don’t re-weight to replicate dividend reinvestment, for dealers to manufacture dividends on the Index constituents anyway. This is because a common means of hedging indices is by buying the underlying stocks, so since the dealer is getting the cashflows in and can pay them out. This is hard to reconcile with the drafting of the 2002 ISDA Equity Derivatives Definitions, unless either (i) for Index transactions, you rather wilfully deemShares” to mean “constituents of the Index”, or (ii) you treat the Index Transaction as really a dynamic custom Share Basket Swap Transaction. Your front office guys won’t like that suggestion, so do you know what the JC’s approach is? Just leave it. This is one of those beautiful places where the lawyers — who have only the faintest grasp of that the front office does at the best of times — do one thing, and the business — which broadly could not care a row of buttons what legal contracts say until it suddenly all goes Pete Tong — does another, ne’er the twain meet, and the respective groups carry on in blissful ignorance of the a gaping conceptual chasm between them.

And speaking of gaping chasms, you know what I’m going to say now, don’t you?


One can draw a serviceable distinction between the “Shares” specified in a Confirmation — which means the abstract concept of a notional participation in the common stock of Teldar Paper etc., represented by a single ISIN — and the precise Number of Shares, being the defined quantity of those Shares relevant in assessing the Equity Notional Amount of a given Transaction.

Where you have a Basket, there will be a weighting of the individual Shares in the Basket which may be articulated in terms of a Number of Shares of that Issuer. This further piques the intellectual challenge.


Sort of like a mini-index, only static (but modifiable by agreement). In the context of delta-one equity derivatives, there’s little difference between a Basket and a collection of single Share Swap Transactions on the individual Issuers comprising the basket.

You might ask why bother even having them, but if you wanted to trade a fixed block, and keep a single UTI, it might make sense — for trading a modified version of a public index, for example.


Dear reader we hope you are not too disappointed not to find a detailed exegesis here. Issuer — the one who issues Shares that you are buying derivatives of.

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  • The JC’s famous Nutshell summary of this clause

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  1. The S&P 500 index, for example, does not factor in any dividend payments. Apparently.