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Template:M intro isda ISDA purpose: Difference between revisions
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====On becoming a shibboleth==== | ====On becoming a shibboleth==== | ||
Through habit and inattention, we work ''around'' the [[easance]]s<ref>Yes, the JC made this word up. Think of it most nearly as the opposite of a nuisance.</ref> once | Through habit and inattention, we work ''around'' the [[easance]]s<ref>Yes, the JC made this word up. Think of it most nearly as the opposite of a nuisance.</ref> we once made to our [[built environment]]. What started out as a the shortest route to market can, through acquiescent disregard, become its own shibboleth: an ''obstacle'' on the road to transaction. | ||
So it is with the {{isdama}}. Once precisely a [[easance]] — an artefact for quickly tidying up and dispensing with formalities it would be laborious to repeat for every trade — it became a mountain of its own. Sure, you only need to climb it, from the bottom, once, that has become a three-month operation. You do not scale an ISDA master agreement the way Alex Honnold scales El Cap. You must take the entire modernist machinery of | So it is with the {{isdama}}. Once precisely a [[easance]] — an artefact for quickly tidying up and dispensing with formalities it would be laborious to repeat for every trade — it became a mountain of its own. Sure, you only need to climb it, from the bottom, once, that has become a three-month operation. You do not scale an ISDA master agreement the way Alex Honnold scales El Cap. You must take the entire modernist machinery of your institution with you. | ||
There are those who miss the good old days. Where bank legal departments have not legislated outright against them — most have — the temptation now is to ask “must we really have an ISDA? Would not a [[long-form confirmation]] do? | There are those who miss the good old days. Where bank legal departments have not legislated outright against them — most have, long since — the temptation now is to ask “must we really have an ISDA? Would not a [[long-form confirmation]] do? | ||
This is how the military-industrial complex of agency operates: it shapeshifts to create work to occupy the available rent.<ref>Remind me to do an article on the [[rent carrying capacity]] of financial services.</ref> | This is how the [[military-industrial complex]] of agency operates: it shapeshifts to create work to occupy the available rent.<ref>see the [[eighteenth law of worker entropy]]. Remind me to do an article on the [[rent carrying capacity]] of financial services.</ref> | ||
====The three aims of an ISDA==== | ====The three aims of an ISDA==== | ||
The {{isdama}} is a framework under which two “[[counterparties]]” can transact [[over-the-counter]] derivatives — mainly, but not only,[[swap]]s. Besides its original appeal as an [[easance]] the ISDA has three main aims: it is a [[relationship contract]]; a [[Credit risk mitigation|credit risk management tool]], and a [[capital optimisation]] tool. | |||
The {{isdama}} is | |||
===== Relationship contract ===== | ===== Relationship contract ===== | ||
[[File:Wedding.jpg|250px|thumb|right|A relationship contract, yesterday.]] | [[File:Wedding.jpg|250px|thumb|right|A relationship contract, yesterday.]] | ||
Firstly, the Master Agreement is a [[relationship contract]]: | Firstly, the Master Agreement is a [[relationship contract]]: an agreement establishing the basic relationship between the parties, reciting their aspirations, dealing with housekeeping, setting out contact details, account numbers, setting up all the dreary details needed to make the transaction process as simple and streamlined as possible. | ||
The Master Agreement does not | The Master Agreement does not itself create any obligations or liabilities. It does not commit anyone to any Transaction. Therefore, curiously, the ISDA Master does not provide ''at all'' for termination without fault on notice. While no Transactions are on foot, the ISDA doesn’t ''do'' anything: it just provides an ''architecture'': walls within which parties may safely play; a roof under which they may comfortably dance ''if they both feel like it''. If they don’t, no one says they have to. | ||
In that | In that an ISDA is painful to put in place — if it only takes a couple of months you have done well — it is also a [[commitment signal]]. It shows you care enough to engage in the painstaking process of working up “[[strong docs]]”. | ||
If the | If the counterparties do decide to dance, they agree economic terms of a {{isdaprov|Transaction}} and sign a {{isdaprov|Confirmation}} that sets out those terms and inherits the remaining terms of their ISDA. | ||
===== Credit risk management===== | ===== Credit risk management===== | ||
Secondly, once the parties ''have'' decided to dance, the ISDA is a [[Credit risk management|credit management]] tool. It gives each party the rights it needs to manage and reduce its [[credit exposure]] to ''the other party'' as a result of all this derivatives trading. These include {{isdaprov|Credit Support}} and [[Close-out Amount - ISDA Provision|Close-out]] rights. | Secondly, once the parties ''have'' decided to dance, the ISDA is a [[Credit risk management|credit management]] tool. It gives each party the rights it needs to manage and reduce its [[credit exposure]] to ''the other party'' as a result of all this derivatives trading. These include {{isdaprov|Credit Support}} and [[Close-out Amount - ISDA Provision|Close-out]] rights. | ||
{{isdaprov|Credit Support}} may take the form of margin “posted” by the counterparty itself against its own exposure and [[guarantee]]s, keep- | {{isdaprov|Credit Support}} may take the form of margin “posted” by the counterparty itself against its own exposure and [[guarantee]]s, [[keep-well]]s and [[letters of credit]] provided by third parties on the counterparty’s behalf. | ||
{{isdaprov|Events of Default}} and {{isdaprov|Termination Events}} permit an innocent party to [[close out]] {{isdaprov|Transactions}} early, should the counterparty breach the agreement, or its creditworthiness deteriorate in more or less oblique ways contrived by the credit department. Some of the Termination Events are concerned with other externalities — change in law, force majeure, tax matters — that don’t directly affect either party’s credit position.) | {{isdaprov|Events of Default}} and {{isdaprov|Termination Events}} permit an innocent party to [[close out]] {{isdaprov|Transactions}} early, should the counterparty breach the agreement, or its creditworthiness deteriorate in more or less oblique ways contrived by the credit department. Some of the Termination Events are concerned with other externalities — change in law, force majeure, tax matters — that don’t directly affect either party’s credit position.) | ||
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We can, in any case, distinguish between welcome “expected events” and unwelcome “[[tail events]]”. | We can, in any case, distinguish between welcome “expected events” and unwelcome “[[tail events]]”. | ||
“Expected events” are the risks you assume by entering the swap in the first place: the economically significant things you believe may, or may not, happen. If these things do not go how you hoped, | “Expected events” are the risks you assume by entering the swap in the first place: the economically significant things you believe may, or may not, happen. If these things do not go how you hoped, you have no complaint: that was the bargain you struck. | ||
“Tail events” are externalities: things that might get in the way of you enjoying the financial risk and reward of the expected events. | “Tail events” are the externalities: things that might get in the way of you enjoying the financial risk and reward of the expected events. If your counterparty blows up. It It suffers sanctions. If the contract is declared illegal. If relevant tax laws suddenly change, the Great King of Terror descending in a flaming chariot, etc.<ref>The arrival of the Great King of Terror is a ''bad'' tail event: there is nothing you can really do to mitigate it. Best not write a swap on it.</ref> | ||
In any case we can see a clear division of labour between the Master Agreement, under which you ''minimise and mitigate'' potential tail risks under all {{isdaprov|Transactions}}, and the {{isdaprov|Confirmation}}, under which you precisely ''describe'' (but do not ''reduce'', as such) ''market'' risk for individual {{isdaprov|Transaction}}s.<ref>This not, ah, a [[Bright-line test|bright-line distinction]], but it is a good rule of thumb. You might put some asset-specific “tail risk” Termination Events in the Confirmation, but for the most part you try to get them all into the Master Agreement.</ref> | In any case we can see a clear division of labour between the Master Agreement, under which you ''minimise and mitigate'' potential tail risks under all {{isdaprov|Transactions}}, and the {{isdaprov|Confirmation}}, under which you precisely ''describe'' (but do not ''reduce'', as such) ''market'' risk for individual {{isdaprov|Transaction}}s.<ref>This not, ah, a [[Bright-line test|bright-line distinction]], but it is a good rule of thumb. You might put some asset-specific “tail risk” Termination Events in the Confirmation, but for the most part you try to get them all into the Master Agreement.</ref> | ||