Template:M intro isda Party A and Party B: Difference between revisions

{{smallcaps|[[Party A and Party B - ISDA Provision|In this episode]]}} of the JC’s series of deep explorations of superficial things in the [[ISDA]] metaverse, we consider the “bilateral” nature of the {{isdama}} and its curious designators: “{{isdaprov|Party A}}” and “{{isdaprov|Party B}}”, and that curious descriptor of both of them: “[[counterparty]]”.  

These set the ISDA apart; give it a sort of otherworldly aloofness; a sense almost of social justice. Other banking and broking transactions use labels which help you orient who, in the [[power structure]], is who: a loan has a “Lender” (always the bank) and “Borrower” always the punter. A brokerage has “Broker” (master) and “Customer” (servant).  

But not the {{isdama}}. From the outside its framers — the [[First Men]] — opted for the more gnomic, interchangeable “{{isdaprov|Party A}}” and “{{isdaprov|Party B}}”.

For most finance contracts imply some sort of dominance and subservience: a large institutional “have” indulging a small commercial “have-not” with debt finance for the privilege of which the larger “have” extracts excruciating covenants and enjoys a preferred place in the queue for repayment among the have-not’s many scrapping creditors.

“A swap contract,” they intoned, “is an exchange among peers. It is an equal-opportunity sort of thing; Biblically righteous in that, under its awnings, one be neither lender nor borrower, but an honest rival for the favour of the Lady Fortune, however capricious may she be.  

“We are equals. Rivals. ''Counterparties''”. Covenants, privileges of credit support and so on may flow either way. They may flow ''both'' ways. In our time of [[regulatory margin]], they usually do.

And, to be sure, swaps ''are'' different from loans and brokerage arrangements. They start off “at market” where all is square. Either party may be long or short, fixed or floating. At the moment the trade is struck, the world infused with glorious ''possibility''. One fellow’s fortunes may rise or fall relative to the other’s and, as a result, she may ''owe'' (“[[out-of-the-money]]”) or ''be owed'' (“[[in-the-money]]”). And swaps, too, are professional instruments. Moms and pops, [[Belgian dentist]]s and the like may take loans and buy bonds, but they don’t, and never have, entered {{isdama}}s.<ref>They may trade [[contracts for difference]] and make spread bets with brokers, but these are standardised, smaller contracts.</ref>

Now the {{isdama}} ''itself'' never uses the terms “Party A” or “Party B”. Being genuinely bilateral, it never has to. Being arbitrary assignations at trade level the labels only get a mention once the symmetry breaks down in the {{isdaprov|Schedule}} and in {{isdaprov|Confirmation}}s, to be clear who is who on a given trade: who is paying the fixed rate and who the floating; which thresholds, maxima, minima, covenants, details, agents and terms apply to which counterparty. This much is necessarily different. Nothing beyond: the {{isdama}} assumes you already know who is who, having agreed it in the {{isdaprov|Schedule}}.

So we agree: for this relationship we will call you “Party B”, and me “Party A”.  

These colourless and generic terms hark from a time where, we presume, the idea of “find and replace all” in an electronic document seemed some kind of devilish black magic. Some kind of [[Tipp-Ex]]-denying subterfuge.  

But anyway. These generic labels still lead to practical difficulties. A [[dealer]] with ten thousand counterparties in its portfolio wants to be “Party A” every time, just for peace of mind and literary continuity when perusing its collection of Schedules, as we know [[dealer]]s on occasion are minded to do.<ref>They are not.</ref> If, here and there, a dealer must be “Party B”, this can lead to anxious moments should one misread such a Schedule and infer its infinite [[IM]] {{csaprov|Threshold}} applies to the other guy, when really, as it ought, it applies to you. Frights like this are, in their way, quite energising.

You quickly get over them when you realise it is your error of construal, not the negotiator’s of articulation.  

Less energising are actual errors: as a group, [[negotiator]]s are redoubtable, admirable creatures but, like all of us fallible and prone to oversight: they may, by lowly force of habit, forget to invert the “Party” labels when inserting the boilerplate {{isdaprov|PPF Event}} rider for that one time in a thousand when the firm is not “Party A”. It is easily done, and just the sort of thing a [[four-eyes check]] will also miss: If it does, no-one will never know — ''unless and until it is too late''.

But there is a better objection: for all our automatic protestations to the contrary, the ISDA is not ''really'' a bilateral contract, and it ''is'' often a financing contract, in economic effect even if not in formal structure. Where there is a customer gaining exposure to a risk and a dealer providing delta-hedged exposure to that risk, a swap is a sort of “synthetic loan”.

{{smallcaps|But except for}} that a class of [[Inter-dealer|inter-dealer]] swap relationships, {{isdama}}s are “bilateral” only really in ''name'': one party — the [[swap dealer]], provides exposures to another, the customer, who consumes them. The customer provides the impulse to trade; the customer elects when to exercise options and terminate positions. The [[dealer]] hedges, calculates values and is burdened with additional [[regulatory capital]] charges if it doesn’t get its [[close-out netting]] right.

Roll forward eighteen years. The world is again on the brink of financial [[Apocalypse]]. The customer is now a [[systemically important financial institution|systemically-important]] leviathan, largely thanks to years of optimistically lax credit sanctioning. But suddenly, it is teetering. The [[Credit officer|chief credit officer]] runs about with her hair on fire and for the first time, ''everyone is staring forensically at the docs''. Suddenly that co-calculation agent fallback dispute mechanism is all that stands between the firm and a three billion dollar abyss. And guess what? ''Some clot transposed Party A and Party B''.

{{smallcaps|Beyond that small}} class of [[inter-dealer]] swap contracts that make up a dealer’s funding and hedging programme — there ''is'' a material distinction between the parties to an swap contract. The asymmetry comes not from whether one is [[long]] or [[short]], or buyer or seller, but from who is ''customer'' and who is ''dealer''.

A [[dealer]] uses the {{isdama}} to earn a [[commission]]. It does this, yes, by providing its customers a changed absolute exposure, but at the same time carefully hedges that exposure so that, but for those fees, the dealer is market ''flat''. Now, it is the nature of the beast that a dealer can’t always ''stay'' market flat: it is too dependent upon the performance of its customers, counterparties and models for that — but this is not for want of trying. The {{isdama}} is as much a borrower/lender arrangement as most other banking arrangements. See [[a swap as a loan|the JC’s long-form essay]] about this.