In the world of hedge funds, trading of over-the-counter (OTC) derivatives in the form of swaps has become ubiquitous, as funds do so for many reasons, including to hedge certain risks, take speculative positions, access difficult-to-trade assets or employ synthetic leverage. See “What Is Synthetic Prime Brokerage and How Can Hedge Fund Managers Use It to Obtain Leverage?
” (Apr. 2, 2010). Most dealers require a fund to execute a variety of complex documents prior to entering into swap transactions on a bilateral basis with the fund. The responsibility for reviewing and negotiating these documents can be a daunting task for a manager’s legal, compliance and operations professionals. In an effort to distill the complexities of these documents and the negotiation process, the Hedge Fund Law Report interviewed several experts that negotiate these agreements on a daily basis on behalf of their fund clients. In this three-part series, we review the various trading agreements required for a fund to engage in the OTC trading of swaps, explain certain key negotiated provisions in swap agreements, discuss common amendments requested by dealers and provide guidance on what are currently viewed as “market terms” for certain provisions. This first article provides background on the various agreements that govern swaps, explains how the Dodd-Frank Act has introduced additional complications to the documentation process and offers advice on best practices for negotiating with dealers. The second article
will review the most commonly negotiated events of default and termination events in the trading agreements and offers suggestions for negotiating these provisions. The third article
will analyze the key considerations for funds with respect to the collateral arrangements – the delivery of margin to mitigate counterparty risk – between the two parties.