Transaction - Equity Derivatives Provision
- Transactions — Sections 1.1 - 1.12
- Underliers — Sections 1.13 - 1.16
- Trade Details — Sections 1.17 - 1.24
- Exchanges, Clearing Systems and Currencies — Sections 1.25 - 1.37
- Trade Features — Sections 1.38 - 1.41
- Knock-ins and Knock-outs — Sections 1.42 - 1.51
This is the Transactions section: the first eleven paragraphs of the 2002 ISDA Equity Derivatives Definitions — twelve, if you include the Confirmations definition which doesn’t really belong anywhere else —set out all the types of Transaction you can have. These break down into:
And can be on a single Index or Share or a Basket of Indices or Shares. All are documented under Confirmations, though with the onset of Master Confirmation Agreements, synthetic prime brokerage and so on, these are no longer the old-fashioned epistles they once were.
1.2. Option Transaction
1.3. Forward Transaction
1.4. Equity Swap Transaction
1.5. Index Transaction
1.6. Share Transaction
1.7. Index Basket Transaction
1.8. Share Basket Transaction
1.9. Basket Option Transaction
1.10. Basket Forward Transaction
1.11. Basket Swap Transaction
Section 1.1 Transaction
Enjoy the uncalled-for cognitive dissonance in that the Equity Derivatives definitions define Transaction — in a rather airy way — even though “Transaction” is already defined in the ISDA Master Agreement, in an equally airy way.
“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.
Section 1.2 Option Transactions
Section 1.3 Forward Transactions
We have a fair bit of information about forward transactions generally in our article on forward sales. This is, on one hard, merely an over-the-counter version of a futures contract, but on another is a fairly important component in asset financing, repurchase and securities lending — all of which are unglamorous, but yet fundamental, components of the plumbing of the financial system.
The older the JC has got, the more important boring old asset financing has seemed.
Section 1.4 Equity Swap Transactions
Section 1.5 Index Transactions
Index Transactions are, on one view, glorigied, big, dynamic share Basket Transactions, only where the rebalancing is carried out by an independent third party. In any case bear in mind you cannot exactly “buy” or, therefore, hedge an Index the way you can buy and directly hedge a Share, so you must hedge by: buying and then rebalancing all the underlying components of the Share, which means you are at the mercy of the market, and there is bound to be some kind of tracking error, or buying a future on the Index, in which case someone else is at the mercy of the market, or an exchange-traded fund which tracks the Index.
Our unscientific hypothesis is that most equity derivative dealers will hedge the Index Swaps they write with physical shares, or futures.
A nice way of bunching up transactions relating to Shares so you don’t have to say “Share Swap Transaction, Share Option Transaction or Share Forward Transaction, as the case may be”, however much your inner “analyst” may compel you to do so. And you have to admit, there is a dirty satisfaction in doing so, isn’t there?
These four sections laboriously cover the “Basket” variations of the foregoing. You can have baskets of Shares, baskets of Indexes (which themselves are glorified baskets) and then Options on baskets, and Forwards on baskets. The possibilities are endless.
Section 1.12 Confirmations
Now back in the day, counterparties exchanged long-form conformations starting out “Dear Ladies and Gentlemen”, and cleaved to a long and tedious form, but in the quick-fire HFT world of Equity Derivatives it quickly became apparent this was quite the waste of trees: Transactions tend to be vanilla, delta-one and traded in high volumes.
Thus, ISDA-sponsored “master confirmations” quickly emerged — sort of intermediate steps between a Schedule and a trade Confirmation allowing parties to agree general terms up front, so the process of confirming was nothing more than a spreadsheet or .xml file exchanged at the end of each day.
Prime brokers developed their own synthetic equity swap master confirmations — somewhat more bespoke than the ISDA MCs, with a further level of standardisation of currencies and tenors, designed to replicate cash equity trading as nearly as possible.
- The JC’s famous Nutshell™ summary of this clause
- A brief disquisition on the financing nature of equity swap.