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. We also have comprehensive knowledge of the global regulatory regimes that govern this market.
The scope of services we provide to our end user derivatives clients is extensive. Day to day, we work with each client to develop model terms for each trading contract it needs and implement a strategy to negotiate these terms. While our end user derivatives practice is officially a part of our Investment Funds practice, we use a multidisciplinary and often multi-jurisdictional approach when servicing our end user derivatives clients. We regularly partner with our bankruptcy colleagues as an increasingly important focus of our practice involves advising clients about mitigating counterparty risk and dealing with regulatory issues. In the face of rapidly developing global regulatory reforms affecting the derivatives markets, we also work closely with our financial institution regulatory colleagues and colleagues in Europe and Asia to help clients navigate the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the European Market Infrastructure Regulation (“EMIR”), the changes to the EU Markets in Financial Instruments Directive known as MiFID II, and other regulatory developments that have extraterritorial effect. Our global network enables us to provide an efficient service and to adopt a consistent approach to regulatory changes affecting our clients and their derivatives documentation and trading practices in the various jurisdictions in which they operate.
Development of Model Terms
A mainstay of Sidley’s end user trading arrangements practice is working with each client to produce a model set of terms for agreements which it negotiates in high volume. Typically, model terms are devised to limit a client’s default and counterparty risks and provide as much certainty as possible in respect of the client’s financing terms. Once we develop model terms, we handle negotiations and seek to achieve these model terms with all of a client’s trading counterparties.
Our thorough knowledge of the template documentation produced by our clients’ dealer counterparties, which frequently forms the core of our clients’ suites of trading documents, and the experience which we have gained over numerous negotiations enable us to swiftly identify key issues of concern to our clients and work with them to find commercial and practical solutions.
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 a client’s existing agreements to identify problems or terms that are not consistent with current market practice or the desired risk profile. We can then propose and help to implement mitigation strategies, including renegotiation of the relevant agreements to adopt terms appropriate to current market practice and the client’s trading strategy.
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 for master confirmations and trade specific confirmations. We also do training workshops on-site with our clients to educate the teams that review trade confirmations on how to approach this important role.
Clearing OTC Derivatives
2013 will mark the beginning of mandatory clearing of certain classes of derivatives for market participants as a result of the Dodd-Frank Act and EMIR is expected to begin in mid to late 2014. Mandatory clearing in the U.S. initially applies only to certain classes of interest rate swaps and index credit default swaps, and it is expected that Europe will follow suit although initially limiting clearing to interest rate swaps. End-users will need to prepare for clearing by entering into new documentation with their chosen clearing brokers. In the U.S., we have developed a set of model terms for clearing documents and we have been negotiating these for our end user clients. In Europe, we have followed closely the development of a market standard addendum for cleared derivatives led by the Futures and Options Association and ISDA. We have advised clients on documentation to establish a clearing relationship on LCH.Clearnet’s SwapClear platform, as well as the associated risks in doing so. We have also conducted analyses of different OTC clearing platforms for clients, including comparisons with existing futures clearing platforms. We anticipate continued significant activity in this area as new clearing platforms develop and as a market consensus emerges as to documentation requirements. Our extensive experience in advising clients on futures customer agreements and futures clearing more generally gives us a natural advantage considering the many features of traditional futures clearing which have been adopted in the new OTC clearing environment.
EMIR came into force in August 2012 and its key provisions relating to clearing, risk mitigation and reporting obligations are due to take effect on a phased basis from the beginning of 2013. Provisions in EMIR covering margining of uncleared swaps are expected to be clarified when The Basel Committee on Banking Supervision and IOSCO publish the minimum standards for such margining requirements. In addition, the market is awaiting clarity on EMIR’s extraterritorial impact. We have been monitoring and advising clients on the effect which EMIR has and will have on their derivatives business.
The original EU Markets in Financial Instruments Directive (“MiFID”) was implemented in November 2007. In October 2011, the European Commission adopted a legislative proposal for the revision of MiFID in the form of a revised Directive and a new Regulation, together commonly referred to as “MiFID II”. The new proposals are designed to take into account developments in the trading environment since the implementation of MiFID in 2007, including advances in technology and gaps in transparency to investors and regulators. MiFID II proposes such measures as a mandatory requirement for certain derivatives contracts to be traded on trading venues and extends pre-trade and post-trade transparency requirements to cover a wider range of financial instruments including certain categories of derivatives. Transaction reporting requirements are also extended to mirror the scope of the revised Market Abuse Directive (given that one of the purposes of transaction reporting is to detect market manipulation and insider dealing). Implementation of the new measures is not expected until at least 2015. Again, we have been monitoring and advising clients on these initiatives.
ISDA regularly publishes protocols to enable market participants to implement compliance infrastructure required by global regulatory reforms. Recent Protocols have included the ISDA August 2012 DF Protocol, the ISDA March 2013 DF Protocol, the ISDA 2013 EMIR NFC Representation Protocol and the ISDA 2013 Reporting Protocol. Upon the publication of each new ISDA Protocol, we regularly provide a generic guidance memo for use by our end user derivatives clients and provide customized advice to those clients that have specific concerns related to adhering to an ISDA Protocol.
Counterparty Risk Management
We work closely with our clients to develop strategies for managing counterparty risk. Since many end users trade a variety of products with a global range of financial institutions, this requires a multifaceted approach. 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. 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, bilateral margining, restricting rehypothecation rights and limiting trading exposure to regulated entities.
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 OTC trades, including the initial margin component (also known as the “Independent Amount”). With respect to cleared OTC derivatives, we have developed creative solutions to restrict discretionary margin increases and position limits with retroactive effect.
We assist clients in structuring and documenting 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.
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 that will service our clients effectively and with cost efficiency. Our practice features senior derivatives practitioners throughout the globe. In addition, we have an extensive base of associates from our Investment Funds, Advisers and Derivatives practice that do a significant amount of derivatives and trading contract work for our end user clients.
Trading Arrangements and Contracts
Types of arrangements and contracts on which we routinely advise include:
- 1992 and 2002 ISDA Master Agreements
- New York law Credit Support Annexes and English law Credit Support Annexes and Credit Support Deeds
- documentation for clearing OTC derivatives
- other OTC derivatives including commodity, and insurance derivatives
- prime brokerage and custody (including segregated account models and sub-custodian arrangements)
- custodial arrangements for funds established in the EU requiring a primary custodian and changes to ‘depositary’ arrangements brought about by the Alternative Investment Fund Managers Directive
- master repurchase agreements and global master repurchase agreements
- securities lending agreements
- exchange-traded derivatives (futures and options)
- margin and/or finance lock-up agreements
- cross-margining agreements
- master netting agreements
- segregated collateral account documentation in both cleared and uncleared markets
- equity derivatives/CFDs and master confirmations
- credit derivatives and master confirmations
- give-up or ‘intermediation’ agreements for CDS and FX transactions
- bespoke derivatives financing and leveraging transactions involving hedge funds (such as total return swaps and options on baskets of hedge funds)
- structured transactions
- UCITS compliant derivatives and collateral documentation