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Diamond Derivatives and Standard Documentation. 28th June, 2007 Shruti Ajitsaria. Documenting Derivatives. Nature of transactions Nature of relationships Credit risk either party may be exposed notional contracts. Derivatives Documentation.

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diamond derivatives and standard documentation

Diamond Derivatives and Standard Documentation

28th June, 2007

Shruti Ajitsaria

Icm: 4723768.1

documenting derivatives
Documenting Derivatives
  • Nature of transactions
  • Nature of relationships
  • Credit risk
    • either party may be exposed
    • notional contracts
derivatives documentation
Derivatives Documentation
  • Documentation published by the International Swaps and Derivatives Association, Inc. (ISDA) dominates
  • For certain domestic markets, documentation produced by national financial markets association is widely used, e.g.:
    • France: FBF/AFB Contract Cadre
    • Germany: BdB Rahmenvertrag für Finanztermingeschäfte
  • Variety of product-specific agreements also exist, e.g., for physically-settled commodies:
    • Standard Coal Trading Agreement (SCoTA)
    • Zeebrugge Hub Natural Gas Trading Trading Terms and Conditions (ZBT)
    • NB: Such physical transactions are incorporated into ISDA documentation by way of various ISDA Annexes that form part of the 2005 Commodity Definitions
slide4
ISDA
  • The trade association representing leading participants in the international privately negotiated (over-the-counter or OTC) derivatives markets
  • Has approximately 800 members from 54 countries on six continents
  • Members include derivatives dealers, non-dealing financial institutions, corporations, law firms, software providers, etc
isda agreement structure
ISDA Agreement Structure
  • Credit Support Documents
  • 2001 Margin Supplement (incorporating 2001 Margin Provisions)
  • 1995 Credit Support Annex (Transfer-English law)
  • 1994 Credit Support Annex (New York law)
  • Annexes
  • North American Power Annex
  • North American Gas Annex
  • GTMA Annex (UK Power)
  • European Gas Annex
  • Global Physical Coal Annex

Bridges

  • 2002 Energy Agreement Bridge
  • 2001 Cross-Agreement Bridge
  • 1996 FRABBA Bridge
  • 1996 BBAIRS Bridge

2002 MasterAgreement

1995 Credit Support Deed (Security Interest-English law)

  • Definitions
  • 2006 Definitions
  • 2006 Fund Definitions
  • 2006 Inflation Definitions
  • 2005 Commodity Definitions
  • 2003 Credit Definitions
  • 2002 Equity Definitions
  • 1998 Euro Definitions
  • 1998 FX and Currency Option Definitions
  • 1997 Government Bond Option Definitions

1995 Credit Support Annex (Japanese law)

  • Confirmations
  • Long form confirmations

2002 Master Agreement Protocol

  • Confirmations
  • Short form confirmations
  • Master confirmation agreements
basic isda master agreement structure
Basic ISDA Master Agreement Structure

ISDA Master Agreement

Confirmation for Interest Rate Swap Transaction

(short form)

Confirmation for Equity Option Transaction

(short form)

Confirmation for Developing Product

(long form)

ISDA Definitions

(2000 Definitions)

ISDA Definitions

(2002 Equity Definitions)

transactions typically documented using isda master agreements
Interest Rate Swap

Basis Swap

Forward Rate Transaction

Commodity Swap

Commodity Option

Equity or Equity Index Swap

Equity Option

Equity Index Option

Bond Option

Interest Rate Option

Cap Transaction

Floor Transaction

Collar Transaction

Currency Swap

Cross Currency Rate Swap

Property Index Transaction

Currency Options

Deliverable

Non-Deliverable

Foreign Exchange Transactions

Deliverable

Non-Deliverable

Swap Option

Credit Swap Transaction

Total Return Swap

Bullion Trade

Bullion Option

Bullion Swap

Weather Derivatives

Emissions Allowances

Inflation Transactions

Physical Commodity Transaction

Transactions Typically Documented Using ISDA Master Agreements
isda master agreement
ISDA Master Agreement
  • Framework agreement
  • Multi-product
  • Sets ongoing legal and credit relationship of the parties (no need to negotiate each time parties enter into a transaction)
  • Does not include economic terms of individual transactions
  • Printed form plus Schedule
3 pillars of the isda master agreement
3 Pillars of the ISDA Master Agreement

SINGLE AGREEMENT

CLOSE-OUT NETTING

FLAWED ASSET/CONDITIONALITY

isda master agreement printed form
ISDA Master Agreement - Printed Form
  • Section 2 - Obligations (includes payment netting; gross-up)
  • Section 3 - Representations
  • Section 4 - Agreements (covenants/undertakings)
  • Section 5 - Events of Default and Termination Events
  • Section 6 - Early Termination (termination of transactions; close-out netting/calculation of amount payable)
  • Section 8 - Contractual Currency (currency indemnity)
  • Section 9 - Miscellaneous (partly boilerplate)
  • Section 12 - Notices
  • Section 13 - Governing Law and Jurisdiction
isda master agreement schedule
ISDA Master Agreement - Schedule
  • The part of the ISDA Master Agreement that is negotiated
  • Used to:
    • make elections
    • Used to make amendments to the printed form
    • Used to include additional provisions
confirmations
Confirmations
  • Confirmations supplement and form part of the ISDA Master Agreement
  • Used to document economic terms of transactions:
    • Who pays and when?
    • How much?
  • Section 2(a)(i) of the ISDA Master Agreement: “each party will make each payment and delivery specified in each Confirmation to be made by it…”
  • Section 9(e)(ii) of the ISDA Master Agreement:

“The parties intend that they are legally bound by the terms of each Transaction from the moment they agree to those terms (whether orally or otherwise). A Confirmation will be entered into as soon as practicable…”

  • Two forms:
    • Long-form
    • Short-form
collateral credit support
Collateral/Credit Support
  • Mitigates credit risk
  • ISDA credit support documents:
    • Credit Support Annexes
    • Credit Support Deed
    • Margin Provisions
definitions booklets
Definitions Booklets
  • Provide a framework of standard terms and provisions for use in documenting transactions
  • Generally, “product-specific”
  • Relied upon by, and incorporated into, short-form Confirmations
  • Sample forms of short-form Confirmation are included at the back of sets of Definitions
diamond derivatives
Diamond Derivatives
  • Cash Settlement based on Index
    • Price Source Disruption
    • Trading Disruption
    • Disappearance of price
    • Material Change in formula
  • Physical Settlement
    • Verification of diamonds
conclusion
Conclusion

“The game isn’t over yet. Derivatives haven’t established their full role in the world.”

Donald Layton

Chase Manhattan Bank

Risk – July 1996 p18