The role of Confirmations in documenting derivatives
Africa Focus
Madhurima BasuSenior Counsel,Banking & Finance
Parties spend a long time in negotiating ISDA Schedules and Credit Support Annexes engaging stake holders including credit and legal teams. However, when it comes to Confirmations, it is often left to the operations teams of their treasury departments to agree with the counterparty with the assumption that the Confirmations are standard.
Now, to start off, you may ask what is a Confirmation? The Confirmation sets out the economic terms of a derivatives transaction entered into under the ISDA Master Agreement and Schedule (“ISDA Agreement”). It includes terms such as who pays, what amounts are paid and when are they paid. It “confirms” the terms of the derivatives transaction entered into between the Parties through other means such as telephone, email or electronic trading platforms among others. However, a Confirmation is also a way to amend the terms of the agreed ISDA Agreement.
In order to standardise Confirmations, each Confirmation incorporates one or more sets of definitions published by ISDA in respect of the relevant asset classes. Each set of definitions lead the way in standardising basic terms of a derivatives transaction relating to that asset class including but not limited to transaction related definitions, how to calculate the relevant amounts payable, the role of a calculation agent, market disruptions and disruption fallbacks as well as including templates of several derivatives transactions. The definitions are amended from time to time based on market events or requirements through supplements or more recently, by amending and restating the definitions.
The structure of all Confirmations are fairly similar. It has similar introductory and closing paragraphs covering the incorporation of a set of ISDA definitions, the reference to the ISDA Agreement that the Confirmation is part of, the details of the trading offices, the accounts for payments, the relevant representations in respect of the Confirmation and the signatures confirming the acceptance of the terms or any other form of assenting to the terms. The economic terms of the relevant transaction (which are the substantive terms of the Confirmation) are included in between the introductory and closing paragraphs. These terms cover who pays, what amounts are paid (including related market conventions such as business days and day count) and when are they paid and any relevant disruptions and fallbacks.
While most treasury operations teams check the economic terms in great details, it is important to note that the correct set of definitions are incorporated in the Confirmation as well as the correct elections and updates are made as the transaction can vary depending on these seemingly small changes.
If you recall from the ISDA Master Agreement, Section 1(b) states that the Confirmation prevails over the ISDA Schedule for the purposes of the relevant transaction and Section 1(c) adds that the ISDA Agreement and all Confirmations form a single agreement between the parties.
This conceptually works as it allows both parties to consider the particular transaction at hand and make any change that is required to effectuate the transaction from a commercial perspective. However, this also adds to the work of the operations team to thoroughly review the Confirmations beyond the commercials to ensure that no additional terms are added to the ISDA Agreement through the Confirmation. In fact, it is more important to review all terms including changes to terms standardised by the ISDA definitions when the transaction is more complex.
The long form Confirmation is a combination of the ISDA Schedule and Confirmation. Certain key ISDA Schedule terms can be negotiated between the parties and included here. The relevant ISDA definitions are still incorporated into the long form confirmation. However, rather than entering into a separate ISDA Agreement, the parties are deemed to have entered into an ISDA Master Agreement, with the terms of the pre-printed form of the ISDA Master Agreement and precise negotiated provisions as elected or amended through the long form confirmation instead of by the ISDA Schedule.
To simplify and standardise some high-volume products, ISDA and other industry bodies such as the Emerging Markets Traders Association have also developed certain master confirmation agreements (“MCA”). There are certain advantages to entering into a MCA. The MCA is relevant for products where each Confirmation include some complex or non-standard terms and those can be agreed in advance. This saves a lot of time when an individual trade is entered into, as only the specific economic terms of a trade can be agreed easily. This also avoids any situation where an event with respect to the transaction occurs before the negotiation on the Confirmation is completed. The MCAs are particularly common for certain FX derivatives (such as non-deliverable forwards) as well as certain equity and credit derivatives. However, it is important to negotiate the terms of the MCA and avoid unnecessary or arduous terms.
As you can see, it is important to get the Confirmation right and not leave it to chance to avoid any unintended consequences. Accordingly, it is important to seek guidance from the party’s legal counsel when reviewing or making policies regarding derivatives Confirmations.
For further information,please contact Madhurima Basu.
Published in September 2024
