Talk:CDS confirmation

From Riski

http://en.wikipedia.org/wiki/International_Swaps_and_Derivatives_Association

Details of individual derivatives transactions are included in Confirmations entered into by the parties to the ISDA Master Agreement. Each Confirmation relates to a specific Transaction and sets out the agreed commercial terms of that trade. Confirmations are generally quite short as they will normally incorporate one or more of the definition booklets published by ISDA. Each of these definition booklets relates to a specific type of derivatives transaction and, in addition to defining terms, they include mechanical provisions (e.g., Articles 5 and 6 of the 2000 ISDA Definitions set out how to calculate the Fixed and Floating Amounts payable under an interest rate swap) which do not then have to be laboriously reproduced in the Confirmation. Possibly the most important aspect of the ISDA Master Agreement is that the Master Agreement and all the Confirmations entered into under it form a single agreement. This is very important (especially for regulated financial companies) as it allows the parties to an ISDA Master Agreement to aggregate the amounts owing by each of them under all of the Transactions outstanding under that ISDA Master Agreement and replace them with a single net amount payable by one party to the other. Transactional netting, dealt with under section 2(c) of the ISDA Master Agreement, allows the parties to net out amounts payable on the same day and in the same currency. The more important use of netting is close-out netting under Section 6(e) of the ISDA Master Agreement. Pursuant to this section, when an ISDA Master Agreement (or, more accurately the outstanding Transactions under it) is terminated (normally following a credit event of some kind), the value of each of the Terminated Transactions is assessed (there are several ways this can be done, but the most usual measure is to determine how much it would cost for a party to enter into a Transaction having commercial terms identical to the Terminated Transaction with an independent third party - this is called the Settlement Amount) and converted into the Termination Currency (which should have been specified in the schedule to the ISDA Master Agreement) and any outstanding Unpaid Amounts are taken into account. The Settlement Amounts (which may be positive or negative depending which party is 'in-the-money' with respect to a particular Terminated Transaction) and unpaid amounts (again positive or negative, depending on who owes them) are added up and a single figure in the Termination Currency is determined payable by one party or the other. The enforcability of the close-out netting provisions is absolutely vital to financial institutions active in the derivatives market since the ability to net allows them to allocate capital only against the net figure they would have to pay on close-out of an ISDA Master Agreement rather than the gross amount. ISDA has obtained legal opinions from all important jurisdictions confirming the effectiveness of the close-out neting provisions in those jurisdictions. Members of ISDA are entitled to rely on these opinions. ISDA also produces a model "Netting Act" which can be adopted by jurisdictions where close-out netting does not work effectively at present.