Five Mistakes Companies Make When Negotiating OTC Agreements
Minneapolis, MN | April 4, 2024 | By: John Trefethen, Director and Co-Founder
In an over-the-counter derivative transaction, also referred to as an OTC derivative, there are several agreements involved to govern the terms and conditions of the transaction. These are the ISDA, the schedule to the ISDA, the credit support annex, and trade confirmations. What follows are five common mistakes companies make when entering into these contracts with a derivatives provider.
Focusing Solely on Pricing. While the pricing of a derivative is important, focusing solely on this can be shortsighted. Companies should also focus on key provisions of the various OTC agreements such as termination events, events of default, collateral requirements, and dispute resolution mechanisms.
Failure to Customize for Specific Needs. Many companies make the mistake of treating the ISDA as a standard contract not realizing there can be amendments to the ISDA detailed in the schedule to the ISDA that will tailor terms specific to their needs and risk profile.
Overlooking Collateral Requirements. The credit support annex will include provisions for collateral posting to mitigate counterparty risk. Failing to carefully negotiate collateral terms, including eligible collateral types, thresholds, and valuation methodologies, can result in liquidity and operational burdens for a company.
Ignoring Counterparty Risk. Neglecting to assess the creditworthiness of counterparties is another common mistake. Companies should conduct due diligence on potential counterparties to evaluate their financial stability and ability to meet obligations under the OTC agreements. Not addressing counterparty risk in the agreements can expose companies to significant financial losses in the event of a default.
Neglecting Documentation Management. After entering into the OTC agreements, some companies fail to establish robust documentation management processes. Properly documenting traded confirmations, amendments, and other communications related to the agreements is essential for maintaining clarity, transparency, and compliance with regulatory requirements.
By avoiding these common mistakes companies can effectively manage risks, optimize terms, and foster successful derivative trading relationships.
Author: John Trefethen, Director and Co-Founder
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