One of the primary goals when the Dodd-Frank Act
introduced central clearing for certain standardized, liquid swaps was to reduce the credit risk between counterparties trading derivatives in the over-the-counter market. For cleared swaps, a regulated clearinghouse is interposed as a counterparty between the two original parties to the transaction, with each party posting margin directly with the clearinghouse. In contrast, uncleared swaps are traded bilaterally, with one party delivering collateral directly to the other party. To mitigate counterparty credit risk with uncleared swaps, parties enter into a credit support annex (CSA) setting forth the collateral arrangements between the parties, such as whether a party is required to deliver collateral and the type of collateral permitted. See “Celent Report Identifies Best Practices for Over-the-Counter Derivatives Collateral Management
” (Jul. 29, 2009). In this final installment in our three-part series, we discuss the key considerations for funds when negotiating the CSA. The first article
provided background on the various agreements that govern swaps and explained the impact the Dodd-Frank Act has had on trading these instruments. The second article
reviewed the most highly negotiated events of default and termination events in swap trading agreements and offered suggestions for negotiating these provisions.