What Is a Master Swap Agreement?
The term master swap agreement refers to a standardized contract between two parties who agree to enter a derivatives agreement that is traded over-the-counter (OTC).
- A master swap agreement is a standardized contract between two parties who enter an over-the-counter derivatives agreement.
- It was established by the International Swaps and Derivatives Association and is internationally recognized.
- The agreement is commonly used between parties who operate in different jurisdictions and in the event that different currencies are involved.
- Master swap agreements provide information on the parties and gives them legal protections while outlining the terms of the deal.
- Two versions exist: the original 1992 contract and an updated 2002 version.
Understanding Master Swap Agreement
The master swap agreement was established by the International Swaps and Derivatives Association (ISDA) in 1992, and is internationally recognized. It's used between parties that operate in different jurisdictions and in the event that different currencies are involved. The master swap agreement identifies each party, outlines the terms and conditions, and provides legal protections to both parties involved. It was updated in 2002.
Swaps are derivative contracts that are established between two parties who want to execute transactions during a certain period of time. These instruments are traded over-the-counter rather than on an exchange. Contracts are rarely traded by individual investors (if at all), which means this market is dominated by financial institutions and investment firms.
The International Swaps and Derivatives Association developed a standardized contract to streamline and provide structure to the agreement process. The organization was founded in 1985 by the private derivatives market to make it safer and more efficient for participants. It provides documents that help reduce risks associated with these financial instruments while increasing transparency.
One of these documents is the ISDA's master swap agreement. This is a contract that standardizes the agreements between two parties who agree to exchange swaps. Since these transactions are executed OTC rather than on an exchange, there's a greater chance of default. The contract outlines some information, including:
- The two parties entering the transaction
- The terms and conditions of the arrangement
- Events of default
- Termination details
- Other legalities of the deal
The document was standardized as a way to help parties who enter into agreements with one another, especially when they operate in different jurisdictions. It also provides provisions for transactions involving different currencies.
Signing a master swap agreement makes it easier for the same parties to engage in additional transactions in the future because these can be based on the initial agreement.
Although the ISDA's master swap agreement is a standardized contract that is recognized internationally, parties aren't required to enter into this agreement in order to execute trades on swaps. This means that two parties can enter into this kind of derivatives agreement initially without signing a contract.
If they decide to pursue this route, both parties agree to a vanilla ISDA agreement, which comes without any special addendums. Going into this type of agreement doesn't provide them with any special protections. They are, however, required to sign a confirmation saying that they promise to negotiate an ISDA agreement within 30 to 90 days.
History of Master Swap Agreements
The master swap agreement established in 1992 is known as the Multicurrency–Cross Border agreement. It was updated in 2002 to include new provisions, such as damages, interest, and compensation. The new version also amends grace periods outlined in the earlier contract by shortening them.
Both versions are still commonly used by members of the ISDA. The 2002 version is known to be lengthy, with as many as 28 pages.
Contracts and related materials are available to ISDA members for $150 while non-members pay $350.
Provisions of Master Swap Agreement
Both the 1992 and 2002 master swap agreements are divided into 14 sections. These segments help determine and outline the basis of the relationship between each party.
The sections provide provisions for certain situations, such as:
- What happens when at least one of the parties involved declares bankruptcy;
- What takes place when these derivatives contracts are closed or terminated.
As noted above, the 2002 version of the agreement was updated with new provisions, including eight default events and five provisions that outline the termination of the agreement if one or both parties default on the contract.
The ISDA also provides a special schedule in case the parties involved want to make changes to the standard terms of the master swap agreement. This is negotiated by each party and can take as long as three months. The length of the negotiation depends on how complex the contract special terms are and the willingness of each party to cooperate.