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-{{drop|[[a swap as a loan|D]]|uring a typically}} [[The bilaterality, or not, of the ISDA|turgid disquisition]] about the “bilaterality” of the {{isdama}}, JC remarked that, despite ''looking like'' bilateral, even-stevens, un-[[loansome]] things, in fact swaps are ''implied financing arrangements''. Hotly justifying this stance side-tracked the original article, so JC  “[[Let’s take it offline|took things offline]]” and started a whole new article on the topic. Here it is.
+{{drop|[[a swap as a loan|W]]|hile composing}} his [[The bilaterality, or not, of the ISDA|turgid disquisition]] on the “bilaterality” of the {{isdama}}, JC remarked that, despite ''looking like'' bilateral, even-stevens, un-[[loansome]] things swaps are, in fact, ''implied loans''. Hotly justifying this stance side-tracked the original article, so JC  “[[Let’s take it offline|took things offline]]” and started a whole new article on the topic. Here it is.
 To recap the background to that post:
-{{Quote|{{drop|W|hereas most}} finance contracts imply dominance and subservience — a ''lender'' who extracts excruciating covenants, takes mortgages, sharpens knives and so on, and a ''borrower'' whose mortal soul is traduced, suffers repeated indignities but who must yet feign affection through gritted teeth and deep resentment — swaps are ''not like that''.
+{{Quote|{{drop|W|hereas most}} finance contracts imply dominance and subservience — the classic loan has a ''lender'' who extracts excruciating covenants, takes mortgages, sharpens knives and so on, and a ''borrower'' whose mortal soul is traduced, suffers repeated indignities but who must yet feign affection through gritted teeth and deep resentment — swaps are ''not like that''.
-“A swap is an exchange ''among peers''. It is an equal-opportunity, biblically righteous compact between equals. There is no lender or borrower: each participant is an honest rival for the favour of the Lady Fortune, however capricious may she be.”}}
+Swaps, so conventional wisdom would have it, are exchanges ''among peers''. “It is,” cognoscenti are given to say, “an equal-opportunity, biblically righteous compact ''between equals''. There is no lender or borrower to a swap: yes, the transaction may go in and out of the money but, as it does, each participant is an honest rival for the favour of the Lady Fortune, however capricious may she be.”}}
-[[Jolly Contrarian|JC]]’s says that, outside the inter-dealer community, this conventional wisdom is not true.
+''Fiddlesticks''. At least outside the inter-dealer community, and even then, frequently within it, this conventional wisdom is not true.
-An “end user” swap ''is'', in fact, a “synthetic” loan from [[dealer]] to [[customer]]. To the extent regulations require dealers to ''post'' [[variation margin]] outright against their own swap exposures, (rather than simply calling for from their customers to cover customer exposures), the regulations make the financial system ''less'' stable, ''more'' risky, ''more'' leveraged, and ''more'' prone to the market calamities that fueled the global financial crisis.
+In the bigger picture, ''swaps are loans''.
-{{quote|
+An “end user” swap ''is'', in fact, a “synthetic” loan from [[dealer]] to [[customer]]. To the extent regulations require dealers to ''post'' [[variation margin]] outright against their own swap exposures (rather than simply calling for it from their customers), the regulations make the financial system ''less'' stable, ''more'' risky, ''more'' leveraged, and ''more'' prone to the market calamities that fueled the global financial crisis. Bilateral variation margin is a category error.
-Bilateral variation margin is a category error. ''Swap dealers should not collateralise their customers.''}}
+''Swap dealers should not collateralise their customers.''
 There. I said it.
-Industry veterans may look upon JC slack-jawed as he says this. Regulators certainly will. Being optimistic, they might try to give JC the benefit of the doubt for this flight of fancy, while thinking “''has the old bugger finally lost his marbles''?”
+JC is blessed in having charitable friends who forgive intellectual softness.
-JC is blessed in that his friends are inclined to charity. “Oh, well, I suppose you ''could'' analyse an [[Interest rate swap mis-selling scandal|interest rate swap]] as a pair of off-setting loans,” they are prone to say. “Yes, that seems strictly true. But, dear fellow, it is rather to miss the point, isn’t it? Seeing as the same amount of principal in the same currency flows in both directions at the same time, the principal cancels out.
+“Oh, well,” they are prone to say when the old boy goes off on one, “I suppose you ''could'' analyse an [[Interest rate swap mis-selling scandal|interest rate swap]] as a pair of off-setting loans. Yes, that seems strictly true. But, dear fellow, is it not rather to miss the point? Seeing each party lends to the other, and as notional principal flows in both directions at the same time, the loan, as you put it, cancels out. The parties to a swap are not ''really'' lending to each other, old thing.”
-The parties to a swap are not ''really'' lending to each other, old thing.”
 ====Customers and dealers====
-{{drop|B|ut this is}} not what the JC means. He means to say that when a dealer provides a swap to a customer, economically, the dealer lends, outright, to the customer. One way.
+{{drop|B|ut this is}} not what the JC means. When a dealer provides a swap to a customer, economically, the dealer lends, outright, to the customer. One way. The customer doesn’t get the money, but that doesn’t matter. The money goes on financing the hedge.
-Now, far out in space, beyond the cramped Oort cloud of inter-dealer relationships, there is a boundless universe of “end user” swaps. Here, one party is a “dealer” and the other — the “end user” — is a “customer”. These are the great majority of all swap arrangements in the known universe. Hence, the expressions “[[sell side|sell-side]]” — the dealers — and “[[buy side|buy-side]]” — their customers.
-The difference between ''customer'' and ''dealer'' on a swap is not who is “long” and who “short” — one of the great [[Swappist Oath|swappist]] beauties under the ISDA framework is that customers can go long ''or'' short, as they please — nor on who pays “fixed” and who “floating”.
+Now there is a boundless universe of “end user” swaps. Here, one party is a “dealer” and the other — the “end user” — is a “customer”. These are the great majority of all swap arrangements in the known universe. Hence, the expressions “[[sell side|sell-side]]” — the dealers — and “[[buy side|buy-side]]” — their customers.
-The difference between customer and borrower is ''who, economically, is borrowing''.
+The difference between ''customer'' and ''dealer'' on a swap is not who is “long” and who “short” the swap exposure — one of the great [[Swappist Oath|swappist]] beauties of the ISDA framework is that customers can go long ''or'' short, as they please — nor on who pays “fixed” and who “floating”.
-For a ''customer'' the object of any {{isdaprov|Transaction}} is to ''change its overall market exposure'': to get into positions it did not have before, or get out of ones it did.
+The difference between customer and borrower is ''who is lending and who is borrowing''.
+====The capital cost of changing your position====
+{{drop|F|or a customer}}, the object of any {{isdaprov|Transaction}} is to ''change its overall market exposure'': to get into a position it did not have before, or get out of one it did.
-This sounds obvious enough. But dealers do ''not''. Dealers stay ''flat''.
+But dealers do ''not'' do this. Dealers stay ''flat''.
-“Hang on, though, JC: if a swap is bilateral, how ''can'' that be so? Does it not follow that if the ''customer'' changes its position one way, the dealer must dp so the other way?”
+“Hang on, though, JC: if a swap is bilateral, how ''can'' that be so? Does it not follow that if the ''customer'' changes its position one way, the dealer must do so the other way?”
-In the narrow confines of the specific {{isdama}} perhaps. But in the wider context of the parties overall net positions, ''no''.
+In the narrow confines of a specific {{isdaprov|Transaction}} perhaps. But the narrow Transaction is not the whole picture. In the wider context of the parties overall net risk positions, this does not happen. Customers change their positions
 The dealer “provides” exposure by sourcing it in the market, delta-hedging it, and charging its customer a [[commission]]. There are all kinds of enterprising and funding-efficient ways it can do so, but fundamentally, a dealer stays market-neutral. The customer’s credit risk for the life of the trade, is all the excitement the dealer wants. As long as its market side hedges work, the only market risk the dealer takes comes about if the customer fails. That is to say, the dealer has customer ''credit'' exposure for as long as the customer stays in its risk position. The customer decides when to exit: as long as it is not solvent the dealer is committed to staying in. If the customer wants to exit, the dealer will make a price.