International Swaps and Derivatives Association
|Headquarters||New York City|
The International Swaps and Derivatives Association (ISDA) is a trade organization of participants in the market for over-the-counter derivatives. It is headquartered in New York, and has created a standardized contract (the ISDA Master Agreement) to enter into derivatives transactions. In addition to legal and policy activities, ISDA manages FpML (Financial products Markup Language), an XML message standard for the OTC Derivatives industry. ISDA has more than 820 members in 57 countries; its membership consists of derivatives dealers, service providers and end users.
ISDA was initially created in 1985 as the International Swap Dealers Association and subsequently changed its name switching “Swap Dealers” to “Swaps and Derivatives”. This change was made to focus more attention on their efforts to improve the more broad derivatives markets and away from strictly interest rate swap contracts.
In 2009 a New York Times article mentioned that in 2005 the ISDA allowed rule changes to CDO payouts (Pay as You Go) that would benefit those who bet against (shorted) mortgage-backed securities, like Goldman Sachs, Deutsche Bank, and others.
ISDA has offices in New York, London, Hong Kong, Tokyo, Washington D.C., Brussels and Singapore. It has more than 800 member firms from six continents. The current Chief Executive Officer is Robert G. Pickel, who joined ISDA in 1997.
ISDA Master Agreement
The ISDA Master Agreement is typically used between a derivatives dealer and its counterparty when discussions begin surrounding a derivatives trade. There are two basic forms of Master Agreement: single jurisdiction/currency and multiple jurisdiction/currency. One of these documents is generally combined with a Schedule to set out the basic trading terms between the parties; each subsequent trade is then recorded in a Confirmation which references the Master Agreement and Schedule. The terms of the Schedule are often negotiated, and many firms have preferred versions of the Schedule.
The ISDA Master Agreement was first published in 1992, and a second edition was published in 2002. The second edition was drafted in response to market difficulties in the late 1990s, and could be adopted either in a unified form or as standard form amendments to the first edition. Key changes in the second edition include:
- Shortening the grace period for payment defaults from three business days to one business day [Refer Section 5 (a)(i) of 2002 version]
- Introduction of a force majeure provision as a termination event
- Introduction of a set-off provision [Included in the 2002 version in Section 6(f)]
- Conformation of jurisdiction clause to the Brussels Regime
- Introduction of Close-out Amount
On April 8, 2009, ISDA introduced further compulsory modifications known as the "Big Bang Protocol." The key changes introduced by this protocol include:
- Introduction of "auction settlement" to eliminate the need for credit event protocols to settle CDS transactions
- Automatic incorporation of Determinations Committee resolutions into the terms of standard CDS contracts
- "Look back" provisions, also known as "backstop dates," which institute a common standard effective date for CDS transactions
The Protocol also introduced more standardized terms in order to limit the scope of negotiation in individual CDS transactions, thus making individual contracts more fungible in trading.
ISDA's report commissioned by the "UK Financial Services Authority on behalf of the international group of OTC derivative supervisors asked ISDA in October 2009 to conduct a broad market review of bilateral collateralization practices for OTC derivatives to facilitate better understanding of current market practice, especially as it relates to the different types of counterparties active in the market."(ISDA & 2010 2)
Possibly the most important aspect of the ISDA Master Agreement is that the Master Agreement and all the Confirmations entered into under it form a single agreement. This is very important (especially for regulated financial companies) as it allows the parties to an ISDA Master Agreement to aggregate the amounts owing by each of them under all of the Transactions outstanding under that ISDA Master Agreement and replace them with a single net amount payable by one party to the other. Netting, dealt with under section 2(c) of the ISDA Master Agreement, allows the parties to net out amounts payable on the same day and in the same currency.
The more important use of netting is close-out netting under Section 6(e) of the ISDA Master Agreement. Pursuant to this section, when an ISDA Master Agreement (or, more accurately the outstanding Transactions under it) is terminated (normally following a credit event of some kind), the value of each of the Terminated Transactions is assessed (there are several ways this can be done, but the most usual measure is to determine how much it would cost for a party to enter into a Transaction having commercial terms identical to the Terminated Transaction with an independent third party - this is called the Settlement Amount) and converted into the Termination Currency (which should have been specified in the schedule to the ISDA Master Agreement) and any outstanding Unpaid Amounts are taken into account. The Settlement Amounts (which may be positive or negative depending which party is 'in-the-money' with respect to a particular Terminated Transaction) and unpaid amounts (again positive or negative, depending on who owes them) are added up and a single figure in the Termination Currency is determined payable by one party or the other. The enforcability of the close-out netting provisions is absolutely vital to financial institutions active in the derivatives market since the ability to net allows them to allocate capital only against the net figure they would have to pay on close-out of an ISDA Master Agreement rather than the gross amount. ISDA has obtained legal opinions from all important jurisdictions confirming the effectiveness of the close-out netting provisions in those jurisdictions. Members of ISDA are entitled to rely on these opinions.
ISDA also produces a model "Netting Act" which can be adopted by jurisdictions where close-out netting does not work effectively at present.
Credit support annex (CSA)
ISDA also produces a credit support annex which further permits parties to an ISDA Master Agreement to mitigate their credit risk by requiring the party which is 'out-of-the-money' to post collateral (usually cash, government securities or highly rated bonds) corresponding to the amount which would be payable by that party were all the outstanding Transactions under the relevant ISDA Master Agreement terminated. Collateral other than cash is usually discounted for risk, that is, the pledgor would have to post collateral in excess of the potential settlement amount.
Since 1998, ISDA has been responsible for releasing a series of interest rate swap reference rates for four currencies (Euros, British pounds, Swiss francs, U.S. dollars) under the name ISDAfix.
Credit events and determinations committees
ISDA has five Determinations Committees, each having jurisdiction over a specific region of the world (the Americas, Asia excluding Japan, Australia/New Zealand, EMEA and Japan). Each committee consists of ten voting dealers and five voting non-dealer asset managers. The committees make official, binding determinations regarding the existence of "credit events" and "succession events" (such as mergers), which may trigger obligations under a credit default swap contract.
Since July 2009, the primary means of resolving a credit event is auction settlement, where holders of applicable instruments (as decided by the relevant determinations committee) auction their instruments to potential buyers at a set price.
In March 2012, ISDA issued a statement declaring that Greece, through passing legislation that forces losses on all its private creditors, has triggered the payment on default insurance contracts, thus instigating a credit event. The ISDA said the use of "collective action clauses (CACs) to amend the terms of Greek law-governed bonds issued by The Hellenic Republic such [as] the right of all holders of the Affected Bonds to receive payments has been reduced."
ISDA also creates industry standards for derivatives and provides legal definitions of terms used in contracts. An example is the 1999 ISDA Credit Derivatives Definitions, which provide basic definitions for credit default swaps, total return swaps, credit linked notes and other credit derivative transactions.
A controversy resulted over the definition of a "restructuring event" in connection with the August 2000 restructuring of USD 2.8 billion of debt by an insurance company. This prompted complaints from protection sellers in credit default swaps, who had to compensate for an event that was seen as normal in the credit business. There was also a fear of a conflict of interest, since protection buyers had nothing to lose by agreeing to restructuring. (Protection buyers included some of the insurance company's lenders.)
- Swap (finance)
- National Futures Association
- Credit default swap
- Currency swap
- Foreign exchange swap
- Interest rate swap
- Swap Execution Facility
- Central Counterparty Clearing
- Clearing house (finance)
- List of acronyms: European sovereign-debt crisis
- ISDAa (6 August 2012). "ISDA Primary Members" (PDF). International Swaps and Derivatives Association. p. 9. Retrieved 9 August 2013. "The list of 196 primary members include Glencore International AG, BP Plc, Koch Supply & Trading, LP, Citadel Securities LLC, Citigroup, Credit Suisse, Daewoo Securities Co., Ltd. investment banks such as Deutsche Bank AG, J.P. Morgan Chase & Co., Barclays Capital, Bank of America Merrill Lynch, BNP Paribas, Citigroup, Credit Suisse, The Royal Bank of Scotland plc (RBS Greenwich?) and UBS AG."
- About ISDA
- Banks Bundled Bad Debt, Bet Against It and Won By GRETCHEN MORGENSON and LOUISE STORY, December 23, 2009, New York Times
- Bushan K. Jodomar, The ISDA Master Agreement - The Rise and Fall of a Major Financial Instrument (August 24, 2007).
- HM Revenue & Customs, CFM13100 - Understanding corporate finance: derivative contracts: documentation: the ISDA Master Agreement.
- Stacy-Marie Ishmael, Lehman, Metavante and the ISDA Master agreement, FT Alphaville (September 30, 2009).
- Robin Wigglesworth, Derivatives: ‘In need of robust architecture’, Financial Times (May 12, 2010).
- Slaughter and May, 2002 ISDA Master Agreement: Guide to Principal Changes (March 2003).
- Mallesons Stephen Jaques, The 2002 ISDA Master Agreement (February 2003).
- ISDA Announces Successful Implementation of ‘Big Bang’ CDS Protocol; Determinations Committees and Auction Settlement Changes Take Effect (press release, April 8, 2009)
- Eric Witschen, "The CDS Revamp," Bloomberg Markets, May 2010 (pp. 115-116).
- ISDA (1 March 2010) (PDF). [http://www.isda.org/c_and_a/pdf/Collateral-Market-Review.pdf Market Review of OTC Derivative Bilateral Collateralization Practices] (Report). International Swaps and Derivatives Association, Incorporated (ISDA). pp. 57. http://www.isda.org/c_and_a/pdf/Collateral-Market-Review.pdf. Retrieved 9 August 2013. [The list of ISDA 196 primary members in 2012 included Glencore International AG, BP Plc, Koch Supply & Trading, LP, Citadel Securities LLC, Daewoo Securities Co., Ltd. and market makers investment banks such as Deutsche Bank AG, J.P. Morgan Chase & Co., Barclays Capital, Bank of America Merrill Lynch, BNP Paribas, Citigroup, Credit Suisse, The Royal Bank of Scotland plc (RBS Greenwich?) and UBS AG as well as numerous national banks such as National Australia Bank Limited National Bank of Abu Dhabi National Bank of Canada National Bank of Greece National Bank Trust. Energy corporations listed include Centrica Energy Limited, Shell Energy North America (US), L.P. and Totsa Total Oil Trading S.A. The list of 296 associate members include TriOptima, IntercontinentalExchange, Inc., Standard & Poor's, Reuters, LCH.Clearnet Limited, Bloomberg Financial Markets, Deloitte LLP, Algorithmics, Inc., Markit Group Limited and MarkitSERV LLC. Lay summary]. "The objective of the review is to enable a more complete appreciation of the use of collateral as a credit risk mitigant across the diverse OTC derivative market, including (generically) the motivations, capabilities, limitations, and typical practices of market participants engaging in collateralization. While the dealer segment of the market is the largest and most systemically significant subset of market participants and has received a high degree of scrutiny and analysis in recent times, there is an interest in developing a similarly complete view of collateral in the wider market from a credit risk mitigant perspective. This review will facilitate the assessment of whether any systemic risks exist, and if so, whether any reforms to collateral practice should be implemented to address any such risk in any segment of the market"
- 2006 Model Netting Act
- "ISDA declares Greek credit event; CDS payments triggered", Reuters, 9 March 2012