Sidley has an international derivatives and trading arrangements practice that focuses on the needs of the end user or “buy” side of the market. A significant proportion of our end user clients are hedge funds, hedge fund managers and other investment advisers. We also represent corporations, sovereigns, insurance companies, private clients (such as foundations), mutual funds and other end users. Our end user derivatives team knows the end user market well, from the documents to the counterparties that produce them.
The derivatives market has undergone significant changes in the last few years and will continue to do so for some time, long after the dust settles from the current regulatory reform efforts. The financial crisis of 2008 has resulted in increased concerns about managing counterparty risk and dealing with uncertainty regarding margin and financing terms. We are well positioned to handle the next phase of the derivatives markets, thanks to our global reach and the breadth of our practice.
Trading Arrangements and Contracts
Types of arrangements and contracts on which we advise include:
- prime brokerage, custody and clearing (including segregated account models and sub-custodian arrangements)
- custodial arrangements for UCITS, QIFs, PIFs, SIFs and other EU funds
- securities lending
- master repurchase agreements and global master repurchase agreements
- 1992 and 2002 ISDA Master Agreements
- NY law Credit Support Annexes and English law Credit Support Annexes and Credit Support Deeds
- segregated collateral account documentation
- equity derivatives/CFDs and master confirmations
- credit derivatives and master confirmations
- facility agreements for CDS and FX, including give-up arrangements
- umbrella agreements for multiple counterparties
- other OTC derivatives including commodity, insurance and property derivatives
- exchange-traded derivatives (futures and options)
- OTC clearing
- cross-margining agreements
- master netting agreements
- margin and/or finance lock-up agreements
- mitigation of counterparty risk/asset protection strategies
- UCITS III-compliant derivatives and collateral documentation
- bespoke derivatives financing and leveraging transactions involving hedge funds (such as total return swaps and options on baskets of hedge funds)
- structured transactions
Limiting Liquidity Risk Through Margin Lockups and Other Tools
Understanding with as much certainty as possible the margin and financing terms for trading positions is an important concern for many clients, particularly following the market volatility of late 2008. We work with clients to develop tools to manage financing terms effectively. These include prime brokerage margin lockups that provide for financing headroom and substitution of new trades. We also work with clients to negotiate certainty over discretionary margin components of their over-the-counter trades, including the initial margin component (also known as the “Independent Amount”).
Counterparty Risk Management
We work closely with our clients to develop strategies for managing counterparty risk. This requires a multifaceted approach for a typical end user that trades a variety of products with a range of financial institutions worldwide. In addition to a thorough knowledge of documentation issues, an effective counterparty risk analysis requires understanding how these financial institutions are regulated and the insolvency regimes that apply to them. We are finding that the most effective tools to limit counterparty risk are those that call upon our global experience in the areas of bankruptcy, secured transactions, financial services regulation and derivatives. Effective risk mitigation typically requires a combination of strategies, including use of third party custody arrangements, implementing bilateral margining, restricting rehypothecation rights and limiting trading exposure to regulated entities.
Development of Model Terms
A core component of Sidley’s end user trading arrangements practice is working with each client to come up with a model set of terms for agreements which it negotiates in high volume, like ISDA Master Agreements, master repurchase agreements, prime brokerage agreements and margin lockups. Typically, model terms focus closely on limiting a client’s default risk and counterparty risk, as well as providing as much certainty as possible over the client’s financing terms. In the ”post crisis” environment, model terms should also make sure that close-out provisions of ”nonstandard” agreements work properly. We handle negotiations and seek these model terms with all of a client’s trading counterparties.
Review of Existing Trading Agreements and Upgrading Trading Terms
Many end users may not be fully aware of weaknesses and potential risks in their existing trading agreements. Our derivatives and trading contracts team is equipped to conduct an in-depth review and analysis of clients’ existing agreements to identify problems or terms which are not consistent with current market practice. We can then propose and help to implement mitigation strategies, including renegotiation of the relevant agreements or the adoption of up-to-date trading documentation consistent with the most current models.
Confirmation review is an area of risk that is often overlooked. End users who take great care to negotiate their ISDA Master Agreements sometimes overlook the fact that these agreements will be overwritten by inconsistent terms in a trade confirmation. To address this, we work closely with clients to develop a set of ideal trade terms to implement in high volume master confirmations and trade specific confirmations. We also do training workshops on-site with our clients to educate the teams that review trade confirmations about how to approach this important role. In addition, Sidley’s derivatives team includes lawyers who are highly experienced in these complex derivatives contracts and who can help clients with difficult trade-specific issues.
We assist clients in the structuring and documentation of structured derivative products to finance exposure to an asset or a basket of assets. Our combined funds, financing and derivatives experience provides solutions for clients who are contemplating such non-standard or “bespoke” deals.
With the imminence of financial regulatory reform and a push toward central clearing of over–the-counter derivatives transactions, many end users are likely to find that some or all of their derivatives trades are regulated, centrally cleared and possibly exchange-traded. We have carried out extensive analysis of the risks, concerns and benefits to the end user of the central clearing platforms proposed for credit default swaps. Once again, we find ourselves calling upon our global experience, since addressing these issues requires input from our global financial regulatory, derivatives and insolvency lawyers.
Strength in Numbers
An important strength of our end user derivatives and trading arrangements practice is that we have a large number of lawyers with a core practice in this area. This enables us to assemble teams which will service our clients effectively and with cost efficiency. Our practice is led by senior derivatives practitioners in three key offices: Chicago, New York and London. In addition, we have an extensive base of associates from our investment funds, advisers and derivatives practice team that do a significant amount of derivatives and trading contract work for our end user clients.
A Global Practice
The issues raised in the course of negotiating trading arrangements for our end user clients frequently require us to call upon the experience and local knowledge of our colleagues in key jurisdictions. We are fortunate to be a part of Sidley’s internationally ranked practice that services investment funds and advisers worldwide, with colleagues throughout the globe experienced in areas like fund formation, fund regulatory, tax, ERISA, insolvency and financial services regulation.
Dodd-Frank Essentials for End Users of OTC Derivatives
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), signed into law on July 21, 2010, mandates comprehensive changes to the U.S. over-the-counter (“OTC”) derivatives market. We are providing a series of updates, “Dodd-Frank Essentials for End Users of OTC Derivatives,” aimed at our end-user or buy-side clients to discuss the implications of this law on their day-to-day activities. To view all of these updates, click here.