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PLI’s Fundamentals of Swaps & Other Derivatives 2016
Derivatives Documentation: Overview of the ISDA Architecture
Confirmations and ISDA’s Credit Support Annexes
October 24, 2016
New York
GuyLaine Charles
Teigland-Hunt LLP
New York
1
What is a Confirmation?
Typically, there are no product specific terms in the
ISDA Master Agreement.
Confirmation is the document memorializing the trade.
Master Confirmations contain all the terms relevant to a
particular product to be traded which allows parties to
simply agree on the economic terms whenever a trade
is entered into.
2
What are the Definitions?
Product specific terms that are incorporated by reference
in the Confirmations.
Product Definitions Booklets
2014 ISDA Credit Derivatives Definitions
2011 Equity Derivatives Definitions
2006 ISDA Definitions
2005 ISDA Commodity Definitions
2002 Equity Derivatives Definitions
1998 FX and Currency Option Definitions (plus Annex A)
1997 Government Bond Option Definitions
3
Single Agreement
All Transactions are entered into in reliance on the fact that the Master Agreement and all Confirmations form a single agreement between the parties (collectively referred to as this “Agreement”), and the parties would not otherwise enter into any Transactions.
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5
Multiple Transactions under a Single
ISDA Master Agreement
ISDA
Master Agreement
Schedule
2002 ISDA Equity
Derivatives Definitions
Confirmation
(Currency Option)
Confirmation
(Equity Option)
1998 FX and Currency
Option Definitions
5
ISDA’s CREDIT SUPPORT ANNEXES
Today ISDA’s Credit Support Annexes (CSA) are widely used to set forth
details of parties’ mutually agreed collateral arrangements for non-cleared OTC
derivatives.
ISDA’s 2015 Margin Survey shows the following:
90% of all non-cleared OTC derivatives trades are subject to collateral
agreements.
The number of active collateral agreements supporting non-cleared OTC
derivatives transactions was 136,936 at end of 2014 – and approximately 80% are
documented using ISDA’s CSAs.
The remaining 20% include bespoke margin agreements, long-form
confirmations with collateral terms and jurisdiction-specific agreements.
Parties elect types of collateral to be posted, how much, how often, where, etc.
With respect to collateral types, cash represents 76.6% of collateral received, while
government securities constitute 13.4% of collateral received.
6
What is the Credit Support Annex?
Annex to the Schedule to the ISDA Master Agreement.
Parties may choose to enter into a CSA or not.
Provides a contractual framework under NY law to allow
parties:
Collateralize their obligations;
Identify type of collateral that will be acceptable; and
Establish their rights and remedies with respect to the credit
support provided.
7
The Credit Support Annex
in the ISDA Master Agreement Structure
ISDA
Master Agreement
Schedule
Transaction
Confirmation
ISDA Definitions
Booklet
Credit
Support Annex
Paragraph [13]
of CSA
8
Benefits/Drawbacks of Collateralization
Benefits of Collateralization
Counterparty Credit Risk Mitigation
Drawbacks of Collateralization
Operational systems and legal support
Costs of collateral and infrastructure
Legal risk: applicable law and procedures may vary from jurisdiction to jurisdiction
9
Introduction
to ISDA’s Library of Credit Support Documents
ISDA’s existing credit support documentation:
1994 Credit Support Annex (Security Interest – New York Law)
1995 Credit Support Annex (Transfer – English Law)
1995 Credit Support Deed (Security Interest – English Law)
1995 Credit Support Annex (Security Interest – Japanese Law)
2001 ISDA Margin Provisions
2013 Standard Credit Support Annex
10
Introduction
to ISDA’s Library of Credit Support Documents
ISDA’s new credit support documentation:
2016 Credit Support Annex for Variation Margin (Security Interest – New York Law)
2016 Credit Support Annex for Variation Margin (Title Transfer – English Law)
2016 Credit Support Annex for Variation Margin (Loan – Japanese Law)
2016 Phase One Credit Support Annex for Initial Margin (Loan – Japanese Law)
2016 Phase One IM Credit Support Deed (Security Interest – English Law)
2016 Phase One Credit Support Annex for Initial Margin (Security Interest – New York Law)
Parties are free to use other pledge or security agreements; however, the ISDA CSAs are most widely used.
11
New York CSA – General Purpose
Bilateral, mark-to-market form
Includes standard terms regarding:
Grant of security interest in collateral
Method for determining a party’s “Exposure” to the other party
Parties’ obligations to deliver/release credit support
Rights, remedies and duties of parties with respect to credit support supplied
Identifies types of collateral/credit support that are eligible
Cash, treasury securities are typical; other forms possible
Credit terms can be customized (in Paragraph 13) for each party
12
Paragraph 5: Dispute Resolution
Addresses disputes regarding calculations of Exposure and Value of Credit Support
Undisputed amount must be transferred pending resolution of dispute
Dispute resolution methods:
Exposure is recalculated by seeking 4 mid-market quotations for Transactions in dispute
Value of Credit Support is recalculated using procedures specified in Paragraph 13
13
Paragraph 6: Holding and Using Posted Collateral
Eligibility to Hold Posted Collateral; Custodians
Secured Party may be entitled to hold collateral directly (subject to conditions in Para. 13).
If it fails to satisfy conditions, transfer to Custodian may be required.
Alternatively, parties may require Custodian to hold collateral at all times.
Use of Posted Collateral (“Right to Rehypothecate”)
Secured Party may sell, pledge, rehypothecate, invest, use, commingle or otherwise dispose of Posted Collateral (subject to Para. 13 and other conditions).
14
Paragraph 6: Holding and Using Posted Collateral (cont’d)
Note: Section 724 of Dodd-Frank requires a swap dealer to segregate initial margin (aka “Independent Amounts” or “IA”) if requested by a counterparty.
ISDA has published a standardized triparty account control agreement to facilitate implementation of IA segregation arrangements.
“ISDA Amend” now offers electronic platform for making segregation elections and acknowledging annual dealer notices re: segregation.
15
Purpose of Paragraph 13 of CSA
Paragraph 13 (“Elections and Variables”) = negotiated portion of the CSA
Allows parties to:
Specify relationship-specific provisions and elections
Amend, add to standard terms of the Credit Support Annex
Common negotiation points:
Collateral Thresholds
Independent Amounts
Minimum Transfer Amount
Transfer Timing
Valuation Agent
Dispute Rights
Parties’ rights to hold collateral vs. obligation to use a custodian
16
ISDA Collateral Opinion Projects
ISDA has obtained legal opinions relating to creation and perfection of security interests under
New York and English law collateral documents.
Annual updates of these opinions are available to ISDA members.
To date 53 collateral opinions received from: Anguilla
Australia
Austria
Bahamas
Barbados
Belgium
Bermuda
Brazil
British Virgin Islands
Canada
Cayman Islands
Channel Islands (Guernsey)
Channel Islands (Jersey)
Chile
Columbia
Cyprus
Czech Republic
Denmark
England
Finland
France
Germany
Greece
Hong Kong
Hungary
Iceland
India
Indonesia
Ireland
Israel
Italy
Japan
Luxembourg
Malaysia
Mexico
The Netherlands
New Zealand
Norway
Philippines
Poland
Portugal
Quebec
Scotland
Singapore
South Africa
South Korea
Spain
Sweden
Switzerland
Taiwan
Thailand
Turkey
U.S.A
17
Uncleared Margin Rules
Per Section 731 and 764 of the Dodd-Frank Act, regulators have begun imposing both initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization.
CFTC has set margin requirements for non-banks with respect to swaps.
Prudential Regulators (Fed, FDIC, OCC, etc.) have set margin requirements for banking entities with respect to swaps and security-based swaps.
SEC has proposed margin rules for non-banks with respect to security-based swaps, but has not yet finalized its rules.
ISDA has published the 2016 Credit Support Annex for Variation Margin (Security Interest – New York Law) to address the new regulatory requirements with respect to variation margin (“VM CSA”).
18
Key Differences between Existing New York Law CSA and
VM CSA Provision Existing CSA VM CSA
Transaction Scope/Netting Set
• Generally all transactions under an ISDA Master Agreement are covered unless specifically carved out.
• A single CSA covers both IA and VM. • All trades under the ISDA Master
Agreement constitute a “netting set” for the purposes of determining net exposure.
• Adds the term “Covered Transactions” which includes only transactions agreed to between the parties.
• Covered Transactions constitute a “netting set” for the purposes of determining net exposure under the VM CSA (this can include legacy trades or not).
• Other CSAs may exclude Covered Transactions.
Margin • Transfer amounts take into account IA and VM.
• Transfer amounts only take into account VM.
Thresholds • The parties may agree to a collateral threshold amount, which would apply to both IA and VM.
• There is no collateral threshold amount applicable for VM. The term “Threshold” does not appear in the VM CSA.
19
Key Differences between Existing New York Law CSA
and VM CSA ccxvcvxcvx Provision Existing CSA VM CSA
Transfer Timing • Before notification time: by close of business on the next local business day.
• After the notification time: by close of business on the second local business day.
• Default notification time: 1:00PM NY.
• Before notification time: by close of business on the same local business day.
• After the notification time: by close of business on the next local business day.
• Default notification time: 10:00AM NY (this is to allow for same day transfers).
Offset against Other CSAs
• N/A • Allows the parties to elect to offset opposite flows of margin that is not segregated and not prohibited from offset.
Ineligibility of Collateral
• Parties can post any collateral agreed to. • If posted collateral is no longer regulatory compliant it will cease to be Eligible Credit Support (VM) and will have a value of zero by the later of (i) the date the collateral is no longer compliant and (ii) the 5th LBD after the SP has provided notice of lack of compliance.
20
Key Differences between Existing New York Law CSA and
VM CSA Provision Existing CSA VM CSA
Dispute Resolution • Notification of a dispute w/r/t a Delivery Amount or a Return Amount must be made not later than the COB on the LBD following the date the demand is made.
• Notification of a dispute w/r/t a Delivery Amount (VM) or a Return Amount (VM) must be made not later than the COB on the date the Transfer is due.
Interest • Interest earned on Cash collateral is to be transferred to the Pledgor in accordance with Par. 13. If not transferred to the Pledgor, will become Posted Collateral and subject to the security interest.
• Interest Transfers can be netted by the Interest Payer against any Delivery Amount (VM) or Return Amount (VM) (in the form of Cash collateral) owed to the Interest Payer (VM).
• Parties can also elect “Interest Adjustment” and Interest Amount (VM) will, if positive, increase the SP’s collateral and if negative, decrease the amount of collateral held by the SP.
21
Key Differences between Existing New York Law CSA and
VM CSA Negotiated Terms Existing CSA VM CSA
Valuation of Collateral for Margin Calculation
• As agreed by the parties. • As agreed by the parties but haircuts cannot be less than required under the relevant margin rules.
Minimum Transfer Amount
• The minimum transfer amount can be any amount as agree by the parties.
• Can be an amount agreed between the parties, subject to regulatory maximum (e.g. USD500,000 across VM and IM under the CFTC and Prudential regulations).
Eligible Collateral • Any collateral as agreed between the parties.
• Eligible collateral must be compliant with the relevant margin rules.
22
Teigland-Hunt LLP
127 West 24th Street, 4th Floor
New York, NY 10011
Tel: 212-269-1600
Direct email: [email protected]
www.t-hllp.com
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