Derivatives Documentation in a New Market Environment
With the introduction of central clearing for OTC derivatives, financial institutions will have to manage new agreements, with different business rules, in addition to the existing documentation for bilateral trading relationships.
Exari’s Paul Nelmes was recently interviewed by Julia Schieffer of DerivSource and he explained how documentation will change within a Central Counterparty Clearing (CCP) environment and why financial institutions must implement efficient documentation processing methods to avoid increased legal and operational costs caused by the new market requirements.
DerivSource: How does the introduction of central counterparty clearing change the documents used to support OTC derivatives?
Exari: The existing Over-the-Counter (OTC) clearing documentation structure between financial institutions and clients or counterparties in the bilateral trade clearing environment, will be supported by the existing International Swaps and Derivatives Association (ISDA) Master Agreement and supplemental documents/annexes such as Credit Support Annex (CSA), trade confirmations.
In the central counterparty clearing (CCP) environment there will be a significant increase in the amount of documentation and overall, the documentation will be more complex. The terms of the agreements with CCPs may be less favorable to the clearing members than their typical bilateral agreement, and commonly will give the CCP power to make unilateral changes by virtue of incorporating its clearing rules (which they decide when and how to change).
Banks trading with many thousands of derivatives counterparties will be compelled by regulators to clear a certain amount of those trades on a central exchange. However, not all OTC trades will be cleared, so anyone dealing in OTC trades that are not standardized will still need bilateral ISDAs or other master agreements in place.