Investment Banking Operations - ISDA - PDF

Investment Banking Operations Module 12 International Swaps and Derivatives Association + OTC Trade Life Cycle  1. Elaborate International Swaps and Derivatives Association 2. Role of International Swaps and Derivatives Association 3....

Investment Banking Operations Module 12 International Swaps and Derivatives Association + OTC Trade Life Cycle  1. Elaborate International Swaps and Derivatives Association 2. Role of International Swaps and Derivatives Association 3. Understanding ISDA Master Agreement Agenda 4. 5. History of ISDA Master Agreement Schedule and Confirmations 6. Key Provisions in the ISDA Master Agreement 7. Various ISDA Documents 8. Examine the Best Practices of ISDA © Copyright Intellipaat. All rights reserved. Elaborate International Swaps and Derivatives Association © Copyright Intellipaat. All rights reserved. Elaborate International Swaps and Derivatives Association The International Swaps and Derivatives Association (ISDA) is a private trade organization comprising participants in the over-the-counter (OTC) derivatives market, including banks, derivatives dealers, service providers, and end users. ISDA's primary role is to improve the OTC derivatives market by identifying and reducing risks, primarily through the creation and management of standardized contracts like the ISDA Master Agreement. Additionally, ISDA oversees FpML (Financial products Markup Language), an XML standard used in the OTC derivatives industry. It is headquartered in New York City and has a global membership of over 925 entities across 75 countries. © Copyright Intellipaat. All rights reserved. History of ISDA Established: 1985 as the "International Swap Dealers Association, Inc." Name Change: In 1988, renamed to "International Swaps and Derivatives Association" to broaden focus to a wider range of derivatives. 2009 Controversy: Mentioned in a New York Times article for allowing rule changes to CDO payouts ("Pay as You Go") that benefited firms betting against mortgage-backed securities, including Goldman Sachs and Deutsche Bank. Offices: Located in New York, London, Hong Kong, Tokyo, Washington D.C., Brussels, and Singapore. Membership: Over 800 member firms from six continents. Current CEO: Scott O'Malia, who joined ISDA in 2009. © Copyright Intellipaat. All rights reserved. Role of International Swaps and Derivatives Association © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Develops and maintains standardized contracts, such as the ISDA Master Agreement, to facilitate and streamline over-the-counter (OTC) derivatives transactions. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Works to identify, mitigate, and manage risks associated with OTC derivatives to improve market stability and transparency. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Provides a legal framework for derivatives transactions, including model documentation and legal opinions to ensure consistency and clarity in agreements. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Engages in policy and regulatory discussions to advocate for market practices that benefit the derivatives industry and its participants. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Oversees and manages FpML (Financial products Markup Language), an XML standard for electronic trading and processing of derivatives. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Offers resources, research, and training to help market participants understand and navigate the complexities of the derivatives market. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Role of ISDA 1. Standardization 2. Risk Management 3. Legal Framework 4. Regulatory Advocacy Facilitates discussions and initiatives aimed at developing and enhancing the OTC derivatives market globally. 5. Market Infrastructure 6. Education and Research 7. Market Development © Copyright Intellipaat. All rights reserved. Understanding ISDA Master Agreement © Copyright Intellipaat. All rights reserved. ISDA Master Agreement The ISDA Master Agreement is a standardized contract published by the International Swaps and Derivatives Association (ISDA) that governs over-the-counter (OTC) derivatives transactions between two parties. It provides a comprehensive framework for documenting these transactions, including terms and conditions that apply to all transactions conducted between the parties. © Copyright Intellipaat. All rights reserved. ISDA Master Agreement The agreement consists of several components: Schedule Definition Booklets Customizes the master agreement to fit the specific needs of the parties Define terms used involved. in the agreement. Confirmations Document the specifics of individual transactions. Credit Support Master Agreement Documentation Outlines the standard Details any collateral or terms for all transactions. credit support arrangements. © Copyright Intellipaat. All rights reserved. ISDA Master Agreement The ISDA Master Agreement simplifies and streamlines the documentation process by ensuring that the terms are predefined and do not need to be renegotiated for each transaction. While it is commonly used by banks and financial institutions, it is also utilized by a broad range of counterparties in the derivatives market. © Copyright Intellipaat. All rights reserved. Structure of ISDA Master Agreement © Copyright Intellipaat. All rights reserved. History of ISDA Master Agreement © Copyright Intellipaat. All rights reserved. History of ISDA Master Agreement 1985: Introduction of the Swaps Code by ISDA, which included standard definitions, representations, warranties, events of default, and remedies. 1987: ISDA produced three key documents: A standard form master agreement for U.S. dollar interest-rate swaps. A standard form master agreement for multi-currency interest-rate and currency swaps (known as the "1987 ISDA Master Agreement"). Interest rate and currency definitions. © Copyright Intellipaat. All rights reserved. History of ISDA Master Agreement 1990s: Major updates and document production: 1991 ISDA Definitions: Revised version of the Swaps Code, later replaced by the 2000 ISDA Definitions. 1992 ISDA Master Agreement: Revision of the 1987 Master Agreement. User's Guide to the 1992 Master Agreement: Drafted in 1993 to explain each section of the 1992 Master Agreement. Commodities Derivatives Definitions: Drafted in 1993 and supplemented in 2000. Annex for Collateral Documentation: Finalized in 1994, with a User's Guide issued in 1995. 2002: Introduction of the 2002 ISDA Master Agreement. This update was prompted by financial crises in the late 1990s, such as the liquidation of Peregrine Investments Holdings and the 1998 Russian financial crisis. These events tested ISDA documentation and led to a strategic review and comprehensive update of the 1992 Agreement. © Copyright Intellipaat. All rights reserved. Advantages of the ISDA Master Agreement Advantages Streamlined Documentation: Reduces paperwork for future transactions to just brief confirmations. Fewer Disputes: Provides clear definitions and explanations to minimize misunderstandings. Better Risk Management: Includes provisions for netting, collateral, and margining to manage risks. Standardization: Creates a consistent framework for derivatives transactions. Legal Certainty: Ensures enforceability with a widely accepted and recognized structure. Efficient Dispute Resolution: Simplifies and speeds up dispute resolution processes. Flexibility: Allows customization of terms while maintaining a standardized base. © Copyright Intellipaat. All rights reserved. Example of an ISDA Master Agreement Imagine two companies, ABC Inc. and XYZ Corp., which are involved in international finance and located in different countries, want to trade OTC derivatives with each other. To facilitate this, they could enter into an ISDA master agreement, which is a standardized contract outlining how they will manage these transactions. This agreement will detail the applicable laws and procedures for resolving any disputes related to their trades. If disagreements arise, they will be resolved according to the laws and terms specified in the ISDA master agreement. © Copyright Intellipaat. All rights reserved. Schedule and Confirmations © Copyright Intellipaat. All rights reserved. Schedule The schedule is a document used to customize and amend the standard terms of the Master Agreement and Annex. It serves several key functions: Amendments and Customizations: It allows parties to make changes to the standard terms of the Master Agreement and Annex, including adding or altering provisions. Elections: It includes elections for various options presented in the Master Agreement, such as payment methods, default thresholds, and operational details. Additional Terms: It can incorporate additional terms or clauses that are not part of the standard Master Agreement, such as set-off clauses or other specific provisions agreed upon by the parties. Standard Terms: The Master Agreement itself remains unchanged on its face; modifications and customizations are documented in the Schedule rather than altering the printed form of the Master Agreement directly. © Copyright Intellipaat. All rights reserved. Schedule © Copyright Intellipaat. All rights reserved. Confirmations © Copyright Intellipaat. All rights reserved. Confirmations © Copyright Intellipaat. All rights reserved. Key Provisions in the ISDA Master Agreement © Copyright Intellipaat. All rights reserved. Key Provisions in the ISDA Master Agreement Single Agreement Close-Out Netting Payments Representations and Transfer Calculation of Covenants Key Provisions Early Termination Amounts Events of Default Tax Provisions Termination Events Credit Support © Copyright Intellipaat. All rights reserved. Key Provisions in the ISDA Master Agreement The ISDA Master Agreement and all transactions executed under it are treated as a single agreement. This provision ensures that, in the event of default or termination, Single Agreement all transactions can be netted out to determine a single net amount owed by one party to the other. Each party makes specific representations (i.e., statements of fact) regarding its Representations ability to enter into the agreement and the transactions, its status, and the legality and enforceability of its obligations. These are ongoing obligations or promises made by each party. They often include Covenants maintaining required authorizations, complying with laws, and ensuring the accuracy of the representations throughout the term of the agreement. © Copyright Intellipaat. All rights reserved. Key Provisions in the ISDA Master Agreement These are specific events that, if they occur, allow the non-defaulting party to Events of Default terminate the agreement. Common events include failure to make payments, bankruptcy, or a breach of agreement terms. Events, similar to defaults, that can lead to the early termination of the agreement. However, unlike events of default, these do not necessarily imply fault on the part of Termination Events either party. Examples include a change in tax laws or legal or regulatory changes making the agreement illegal. © Copyright Intellipaat. All rights reserved. Key Provisions in the ISDA Master Agreement This provision allows for the netting of obligations if the agreement is terminated due to an event of default or termination event. Instead of settling each transaction Close-Out Netting individually, the parties calculate a single net payment owed by one party to the other. Details regarding how payments should be made, including timing, method, and Payments and Transfers currency. It also outlines what happens if there is a failure to make a payment. Specifies the method for calculating the amounts due upon early termination. Calculation of Early There are several approaches, including Market Quotation (obtaining quotations Termination Amounts from market participants) and Loss (calculating the loss or cost incurred by the non-defaulting party). © Copyright Intellipaat. All rights reserved. Key Provisions in the ISDA Master Agreement Addresses the tax implications of transactions under the agreement, including Tax Provisions withholding taxes, gross-up provisions (where one party compensates the other for any taxes withheld), and tax representations. This refers to collateral that may be posted by either party to secure obligations under Credit Support the agreement. The ISDA Master Agreement often works alongside a Credit Support Annex (CSA), which outlines the terms for posting and returning collateral. © Copyright Intellipaat. All rights reserved. Various ISDA Documents © Copyright Intellipaat. All rights reserved. ISDA Master Agreement Purpose: The cornerstone document that governs the overall relationship between two parties trading derivatives. It provides the framework for all transactions entered into between those parties. Components Master Agreement: The main document setting out the legal framework. Schedule: Customized terms that modify the standard terms of the Master Agreement. Credit Support Annex (CSA): Outlines the collateral requirements and terms for mitigating credit risk. Confirmations: Specifics of individual transactions that are governed by the Master Agreement. © Copyright Intellipaat. All rights reserved. Credit Support Documents Credit Support Annex (CSA): Establishes the rules for collateral (margin) exchange, including what types of collateral are acceptable and the procedures for handling collateral disputes. Credit Support Deed (CSD): Similar to the CSA but used in certain jurisdictions (like the UK) where a deed structure is more appropriate. Credit Support Annex for Initial Margin (IM): Specifies the rules for posting initial margin, a requirement under new regulations for non-centrally cleared derivatives. © Copyright Intellipaat. All rights reserved. ISDA Definitions These provide standardized terms and templates for various types of derivatives products. Some of the most common definitions include: 1992 ISDA Definitions: Early set of definitions for interest rate and currency derivatives. 2006 ISDA Definitions: Updated definitions for interest rate derivatives, widely used in the market. 2021 ISDA Interest Rate Derivatives Definitions: The latest version, modernizing the terms and incorporating fallback provisions for benchmarks like LIBOR. © Copyright Intellipaat. All rights reserved. ISDA Protocols Purpose: Mechanisms to efficiently amend large numbers of contracts to reflect new regulatory requirements or market practices. Examples EMIR Protocols: Amend contracts to comply with the European Market Infrastructure Regulation (EMIR). DF Protocols: For compliance with Dodd-Frank regulations in the U.S. IBOR Fallbacks Protocol: Allows counterparties to amend their contracts to incorporate fallback language for interbank offered rates (IBORs) transitioning to risk-free rates. © Copyright Intellipaat. All rights reserved. ISDA Credit Derivatives Documentation Credit Derivatives Definitions: Provides standardized terms for credit default swaps (CDS) and other credit derivatives. The most widely used version is the 2014 ISDA Credit Derivatives Definitions. ISDA Auction Settlement Terms: Rules for conducting auctions that determine the final settlement price for credit default swaps following a credit event. © Copyright Intellipaat. All rights reserved. Collateral and Margin Agreements ISDA Margin Agreements: Include rules and guidelines for the exchange of variation margin and initial margin under new regulatory requirements. Initial Margin (IM) Documentation: Tailored for non-centrally cleared derivatives to meet regulatory standards. © Copyright Intellipaat. All rights reserved. Equity Derivatives Documentation ISDA Equity Derivatives Definitions: Standardizes terms and templates for equity derivatives, including equity swaps and options. Equity Derivatives Confirmations: Standardized confirmations for different types of equity derivatives transactions. © Copyright Intellipaat. All rights reserved. Examine the Best Practices of ISDA © Copyright Intellipaat. All rights reserved. Best Practices of ISDA Use of ISDA Master Standardize documentation across derivative transactions to ensure legal Agreements and operational consistency. Counterparty Risk Employ netting and collateral arrangements to manage credit risk Management effectively. Adherence to Regulatory Ensure compliance with global regulations, such as Dodd-Frank and Requirements EMIR, including clearing and margining obligations. Legal Certainty and Obtain legal opinions on enforceability and maintain clear, standardized Documentation documentation to reduce legal risks. © Copyright Intellipaat. All rights reserved. Best Practices of ISDA Implement best practices in collateral management and leverage Operational Efficiency automation to enhance operational processes. Market Conduct and Adhere to ISDA codes of conduct to promote ethical behavior, Transparency transparency, and market integrity. Adoption of ISDA Utilize ISDA protocols to efficiently amend contracts and stay compliant Protocols with evolving regulations. © Copyright Intellipaat. All rights reserved. Contact Us 080-4524-9465 [email protected] © Copyright Intellipaat. All rights reserved.