Interpretation - 1992 ISDA Provision
1992 ISDA Master Agreement
Section 1 in a Nutshell™
Use at your own risk, campers!
Full text of Section 1
Related agreements and comparisons
Content and comparisons
But for some refreshing loosie-goosiness in the 2002 ISDA about where one might otherwise define terms, the text of Section 1 is the same in each version of the ISDA Master Agreement.
Section 1 is a gentle introduction indeed to the dappled world of the ISDA Master Agreement: much coming from the “goes without saying, but let’s say it anyway” dept of legal wordwrightery — a large department indeed, in the annals of modern legal practice.
The large slew of definitions are set out in Section 14. the JC considers each in its own write elsewhere.
It wouldn’t be ISDA if there weren’t a hierarchy clause; all this really establishes is the obvious: the pre-printed ISDA Master Agreement itself sits at the bottom and is modified between the counterparties by its Schedule; once negotiated and stuck into the netting database, the Schedule basically sits there unregarded and is modified as needs be for each Transaction under the Confirmation. In point of fact the Confirmations don’t tend to modify anything in the Master and Schedule so much as build on them, but if there is a consistency — and with a document as pedantic and overwrought as the ISDA you just never know — then the most specific, recently edited document will be the one that prevails.
Section 1(c) starts getting a bit tastier in that it comprises the Single Agreement. This is deep ISDA lore, from which all the close-out netting that gives the ISDA Master Agreement its capital efficiency wings flows.
In a nutshell — unless you are doing repackagings, and even then don’t get carried away — make sure you understand what Section 1 is there fore, but don’t mess with it.
Section 1(c): the Single Agreement
Most of Section 1 may be theatrical throat-clearing, but section 1(c) is important — by some lights, the main reason one even has an ISDA Master Agreement: it vouchsafes your close-out netting analysis, purporting to inextricably bind together all Transactions under the ISDA Master Agreement as part of a single, concerted, nettable whole. Should (God forbid) your counterparty have imploded, an unthinking administrator might feel the three-year jet fuel swap you traded in July 2012 had nothing really to do with your six-month interest rate swap from February last year and when it comes to considering who owes who what, the two should be treated as separate, unitary transactions. It might think this quite enthusiastically if one of those transactions happens out-of-the-money to you, and the other one in-the-money. This, at any rate, has been the dominant fear of the Basel Committee on Bank Supervision since it hit upon the idea of capital relief for master netting agreements in 1986.
“Why, that’s dashed bad luck, old man! You have to pay me that out-of-the-money exposure and while this dead parrot owes you on the other trade, the end of the creditors’ queue is that one you can see over there in the far distance, should you have a telescope on you.”
You might be inclined to say, “but wait: we should be able to set these off surely! This is all the same stuff, right! Swaps! They all go together! They’re not unitary transactions at all!”
Well, Section 1(c) — the one that says “it is all a single agreement, and we would never have done any of this if we had thought for a moment it might not be, and to prove it we are saying this out loud at the very inception of our derivatives relationship” is your friend in making that argument. There are similar provisions in other agreements, but none is so classic or elegant as the ISDA Master Agreement’s.
For details freaks
Assignment and its effect on netting and set-off
Could a right to assign by way of security upset close-out netting such that one should forbid parties making assignments by way of security of their rights under the ISDA Master Agreement, for fear of undermining your carefully organised netting opinions?
- An assignment by way of security is a preferred claim in the assignor’s insolvency over the realised value of certain rights the assignor holds against its counterparty. It is not a direct transfer of those rights to an assignee: the counterparty is still obliged to the assignor, not the assignee, and any claim the assignee would have against the counterparty would only be by way of subrogation of the assignor’s claim, should the assignor have imploded in the meantime or something.
- “Nemo dat quod non habet”: the unaffected counterparty’s rights cannot be improved (or worsened) by assignment and, it being a single agreement, on termination of the agreement the assignee’s claim is to the Termination Amount determined under the ISDA Master Agreement, which involves terminating all Transactions and determining the aggregate mark-to-market and applying close-out netting. No one can give what they do not have.
At the point of close-out, the assignee’s right is to any Termination Amount payable to the Counterparty. Therefore any assignment of rights is logically subject to the netting, as opposed to potentially destructive of it.
But: This is only true insofar as your netting agreement does not actively do something crazy, like disapplying netting of receivables which have been subject to an assignment and dividing these amounts off as “excluded termination amounts not subject to netting”. I know what you are thinking. “But why on God’s green earth would anyone do that?” This is a question you might pose to the FIA’s crack drafting squad™, who confabulated the FIA’s Professional Client Agreement, which does exactly that.
Happily, ISDA’s crack drafting squad™ was never quite so cavalier with the ISDA Master Agreement, though.
Equivalents in other agreements
- Single Agreement - GMRA Provision
- Single Agreement - GMSLA Provision
- Single Agreement - GTMA Provision
- ↑ Yes I know: Section 2(a)(iii). We’ll get to that. And in some jurisdictions mandatory insolvency set-off would also spike an administrator’s guns. But for now, let’s say.
- ↑ “A chap cannot give away what he doesn’t own in the first place.”
- ↑ Except under New York law — isn’t that right, rehypothecation freaks?