Safe, Efficient Markets

Key words: ISDA, the SWAPS Code, ISDA Master Agreement, The Schedule, ISDA Definitions, CSA
ISDA

ISDA, known as International Swaps and Derivative Association, fosters safe and efficient derivatives markets to facilitate effective risk management for all users of derivatives.
According to ISDA, the association promotes high standards of commercial conduct and leading industry action on derivatives issues including:

1. THE SOURCE FOR ROBUST AND TRUSTED DOCUMENTATION

The initial goal of ISDA has been the development, drafting, and promulgation of standard form documentation for the OTC derivatives industry. Standard documentations such as the ISDA Master Agreement have helped to reduce credit and legal risk through netting provisions and collateralization:

Netting reduces OTC derivatives credit exposure to 0.6% of notional outstanding while credit exposure after collateralization and netting is about 0.2% of notional outstanding.

2. SECURE AND EFFICIENT INFRASTRUCTURE TO SUPPORT AN ORDERLY AND RELIABLE MARKETPLACE AS WELL AS TRANSPARENCY TO REGULATORS
3. EFFECTIVE RISK MANAGEMENT AND CLEARING
4. THE VOICE FOR THE GLOBAL DERIVATIVES MARKET REPRESENTING THE DERIVATIVES INDUSTRY THROUGH PUBLIC POLICY, ISDA GOVERNANCE, ISDA SERVICES, EDUCATION AND COMMUNICATION

History

ISDA today ranks as one of the largest global financial trade associations, with more than 840 members from 60 countries.

A group of swap dealers began work in 1984 to develop standard terms for interest rate swaps. ISDA was formed as a nonprofit corporation in early 1985.

The Code of Standard Wording, Assumptions and Provisions for Swaps, the SWAPS Code was published in June 1985; an updated expanded edition was released in September 1986.

In 1987, ISDA provided a pair of standard form Master Agreements:
• Interest Rate Swap Agreement for US dollars
• Interest Rate and Currency Exchange Agreement for multicurrency interest-rate and currency swaps

These two agreements collectively referred to as the 1987 ISDA Master Agreements.
Standard form Addenda were issued in 1989 and 1990 to cover interest rate caps and floors as well as swap options.

The 1987 Agreement was revised into the 1992 ISDA Master Agreement entitled the Cross Border Master Agreement and the Single Jurisdiction Master Agreement.
The difference between the documents is that the former is used where the parties are from different jurisdictions and the transactions are likely to involve more than one currency, whereas the latter is meant for contracting parties from the same jurisdiction and the transactions are likely to involve only the local currency.

The 1992 Agreement expanded the product range of derivative products and promoted netting across them as well as took account of changes in laws such as bankruptcy law.

In October 2001, ISDA started a comprehensive review of certain aspects of the 1992 ISDA Master Agreements which resulted in the publication of the 2002 ISDA Master Agreement in January 2003.
The changes represent a fine tuning of the 1992 Agreement.

The ISDA Master Agreement consists of three parts.

1. The main body (Standard Terms) includes provisions relating to interpretation, conditions precedent, netting, withholding tax, representation, undertakings, events of default, termination events, early termination etc.. They should be negotiated between counterparties.

2. The Schedule is used to customize the Master Agreement by amending the Standard Terms.

3. Transaction confirmations. The ISDA has provided several standard confirmations to represent a derivative transaction. A Confirmation consists of mainly economic and financial payment terms.

In 1987, ISDA published the 1987 Interest Rate and Currency Exchange Definitions. In addition, sets of definitions were published:

• 1992 ISDA FX and Currency Option Definitions
• 1993 ISDA Commodity Derivatives Definitions (plus 2000 Supplement)
• 1994 ISDA Equity Option Definitions
• 1996 ISDA Equity Derivatives Definitions
• 1997 ISDA Bullion Definitions (long-form and short-form)
• 1997 ISDA Government Bond Option Definitions
• 1998 FX and Currency Option Definitions11 (plus revised Annex A)
• 1999 ISDA Credit Derivatives Definitions (plus supplements)

For instance, if counterparties enter into a commodity derivatives transaction, they would adopt the 1993 Commodity Derivatives Definitions.

In July 2000, ISDA published the 2000 ISDA Definitions. These definitions represent the result of a thorough review of the 1991 ISDA Definitions.

CSA

One way to overcome the counterparty risk is through collateralization. Most of the cross-border collateralisation of derivatives transactions is documented under the ISDA Credit Support Documents.

The 2001 ISDA Margin Provisions combines Credit support Annexes (under each of English, New York and Japanese Law) and English law Credit Support Deed into a single document.

The most common collateral documents adopted in the derivatives market are the Credit Support Annex governed by New York law (a.k.a. New York Annex), the Credit Support Deed (a.k.a. English Deed) and the Credit Support Annex (a.k.a. English Annex). The last two documents are governed by English law.

Credit Support Documents are divided into the standard terms and the Schedule. These documents are incorporated as part of the Master Agreement with the exception of the English Deed, which is a ‘stand alone document’.

The ISDA Credit Support documentation contemplates a ‘two way’ collateralisation. In other words, either party may, at any given time, be the collateral giver or the collateral receiver.


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