ISDA Master Agreements

Over-the-Counter (OTC) or off-exchange transactions carry inherent risks for both parties, which can make negotiating an agreement difficult and time-consuming. ISDA Master Agreements are vital standard contracts that reduce the time and cost of such negotiations so that a standard form for all transactions can be created.

If your company is considering engaging in OTC trades, you will likely need to negotiate an amendment to an ISDA agreement. A lawyer with experience negotiating ISDA agreements from the Priori network can be vital to protecting your interests in an OTC transaction.  

Understanding ISDAs

ISDA Master Agreements are standard contracts used in Over-the-Counter derivatives transactions and created by the International Swaps and Derivatives Association. There are two major versions in use now: the 1992 version and the 2002 version. ISDAs outline the terms applied to any derivatives transactions between two parties, so that they do not have to be renegotiated every time while ensuring that the risks inherent in trading securities without an intermediary are minimized.

ISDAs are useful, because they have clearly defined contract terms and the main content of the document is never changed, which means that both parties know exactly what to expect. If any changes to the standard form are made, it must be through the use of a clear addendum in a separate document.

Key Terms and Provisions

While it is important to get to know all the terms agreed upon in the version of the ISDA used, there are several key terms in provisions that you should know about in particular.

  • Right to Transfer. The ISDA gives either party the right to transfer obligations of the agreement to a third party in most situations, subject to consent. This is a regularly amended provision, as banks often wish to eliminate the need for consent, especially if to a bank affiliate that has the same credit rating as the bank at the time of transfer.
  • Incorporation of Loan Covenants. Often parties will seek to incorporate certain affirmative and negative covenants contained in the parties’ loans or credit agreements into the ISDA, which would freeze the covenants as they are. If not incorporated, such covenants evolve over time.
  • Most Favored Nation. When a party is contracting ISDAs with many parties at the same time, many will demand a MFN clause that will allow the to take advantage of other potentially better negotiated causes. For this reason, a single standard form can help reduce confusion later.
  • Events of Default. There are eight standard events of default in ISDAs that terminate the agreement on the non-defaulting party’s terms with specified cures for each. The most important of these are failure to pay, breach of agreement, credit support default, cross-default, misrepresentation of material facts and bankruptcy.
  • Termination Events. There are five standard termination events in ISDAs that will end the agreement without fault. They are illegality or lack of proper authorizations, substantial tax events, tax issues related to mergers, credit changes related to mergers and force majeure. 
  • Delivery of Financial Information. Each party is required to produce certain documents prior to a transaction, including financial reports. In any cases, this will include information not publicly available, especially in the case of hedge funds.
  • Non-Reliance Representations. Each party agrees that they are not relying on the other in making the decision on risk, putting the burden on each party in turn to do due diligence.

Additional ISDA Master Agreement Documents

The main ISDA master agreement is generally accompanied by several supplementary documents. The two most common and important are the Schedule and the Credit Support Annex.

Schedule

Amendments to the ISDA Master Agreement are never made directly within the document. Instead, any changes or adjustments to the standard text are made using the Schedule. The ISDA Schedule serves mainly as the place where amendments to and customizations of the Master Agreement and Credit Support Annex are recorded, including which options have been chosen in places within the Master Agreement where there are multiple options presented to the parties, such as payment measures and methods, thresholds relating to certain events of default, and offices through which parties can act. Any additional terms demanded by the parties will also be added in the Schedule.

Credit Support Annex

While optional, almost all Master Agreements are accompanied by Credit Support Annexes. The Credit Support Annex (CSA) is a standard document that defines collateral relationships for derivative transactions subject to the Master Agreement. In the CSA, policies are established defining the mechanics of collateral transfers, acceptable forms of acceptable collateral, the threshold of exposure parties are willing to take on before requiring collateral, requirements for care to be given to collateral, and other similar provisions.

FAQ

How are termination settlements calculated?

Termination settlements in the event of early termination can be calculated in two ways in the 1992 version of the ISDA: loss or market quotation. Either the non-defaulting parties losses are calculated or the value in the market is assessed for a fair price using four separate quotes. Which one will be used is specified in the schedule. 

In the 2002 ISDA, a hybrid method is employed. This employs a more standard and pre-determined close-out settlement.

What the difference between the 1992 and 2002 versions of ISDAs?

Along with the differences in how termination settlements are calculated in the 1992 and 2002 versions, there are four main differences between the two versions:

  • Grace Period. The grace period for failure to pay or other default it reduced from three days to one day in the 2002 version.
  • Ideal Scope. The 2002 version applies to a broader range of specified transactions that are not applicable to the 1992 version, including as repos, reverse repos and securities loans.
  • Force Majeure. Force majeure clauses in the 2002 version specify how these events can cause termination and dictate the dissolution of the transaction after eight business days.
  • Set-off. The 2002 ISDA includes a set-off provision that allows the non-defaulting party to garner other assets of the defaulting party other than the amounts it is owed to set off costs incurred.

Which ISDA Master Agreement year is best?

Only two ISDA versions are commonly in use today: the 1992 ISDA Master Agreement (Multicurrency – Cross Border) and the 2002 ISDA Master Agreement. Both have their advantages and disadvantages depending on your unique financial and legal situation, but neither is objectively better, so long as you are consistent in which version you use. If you want to know which option is best for a potential transaction, it can help to speak to an attorney.  

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