About that ISDA Pt 4(b): The qualities of a good ISDA
Second part of an essay on the essential features of a solid master trading agreement: consistency, simplicity, and if yours aren’t, what you can do to fix it.
In the first part, we canvassed fairness, confidence and clarity. We round up by looking at consistency, simplicity and — in the highly unlikely scenario that your ISDAs aren’t models of elegance — what you can do to change that, and we challenge you to bell the cat under whose yoke your labour.
Last time
Last time we look at fairness, confidence and clarity. Miss that episode? You can find it here👇
But in a nutshell: A fair starting point discourages needless negotiation, and provides all your business will ever need in the formal memorial of your relationship which is, after all, not between hostiles. Hostiles don’t enter contracts with each other: people wanting to do business do. Between them, the commercial imperative governs.
A form that inspires confidence in your own negotiation team — that is, they understand it, can advocate for it and are not afraid of it — enables the team to build a strong, personal relationship and will dramatically cut down on wasteful escalations, inside and out, and tedious trench warfare of the typical text-based negotiation.
A clear form is usable in a crisis. The only time you will ever look at a contract again, once you have signed it, is in a crisis.
Carrying on then:
Consistency
It helps with clarity if, in a scrape, you know what your ISDA will say where it matters without having to go and read it.
This actually happened:
SCENE: We are in the teeth of the global financial crisis. Out the window, a curlicue of black smoke twists from the roof of Bear Stearns. In the harbour, the prow of SS Lehman points skyward and begins to slip between the waves. Distressed passengers float about in Iron Mountain boxes. We are in an executive suite in one of the few remaining ostensibly viable investment banks, where HEAD OF TRADING, a gruff New Yorker, has convened an extraordinary STEERCO of his chief risk personnel.
HEAD OF TRADING: Head of Credit: report please. How is the Lehman portfolio looking?
HEAD OF CREDIT: Oh! (Swoons and collapses in a faint)
HEAD OF TRADING: Legal: I need to know our close-out rights against these fifteen Lehman entities.
GENERAL COUNSEL (Looking pleased with himself): Certainly! I have a crack squad of our best lawyers on it. You will have an answer within forty-eight hours.
HEAD OF TRADING (Going white): What? Forty-eight hours? I want it in forty-eight seconds.
At the point where you need to use your close-out rights, it is too late to start reading contracts.
You might not need to if, when you negotiated them, you controlled quality where it matters. If all your contractual protections are the same, and you know what they say, you would be in a dramatically better place were several of them to blow up at once as, in a crisis, they have a habit of doing.
“This is all very well, JC, but how are we supposed to force a counterparty to take our credit terms? It is a competitive market! No one in their right mind would do that! We must negotiate every time! We must have best in class protections and the strongest possible legal docs. And, plus, we can’t stop our counterparties from insisting on their bespoke terms, you know: this is a client service business! We cannot dictate!”
Quite so: and to get you through the live-long day we commend Serenity’s Prayer to you.
Lord, grant me:
The serenity to accept the things I cannot change
The courage to change the things I can, and
The wisdom to know the difference.
You cannot control everything, it is true. But there are some things you can: the starting point for your forms, for one thing — and some things you certainly cannot, such as a customer’s pet peeves.
But customer pet peeves have the general quality of being correct: customers usually get peeved at plainly unreasonable things brokers put in their contracts which they know, and the broker knows, it would never use. Few customers get “peeved” at Failure to Pay or Bankruptcy Events of Default.
So, take these peeves seriously. If you configure your human system — AKA your negotiation team — to be on the look out for them, you can constantly sand off rough edges when you encounter them — see “jidoka” above — then these pet peeves can serve as a kind of carborundum.
It is a curious fact that template augmentations — callouses and scar tissue from previous wounds, bumps and scrapes — tend to stick, whereas template simplifications, if they ever even happen, do not. This is a cultural matter: no-one likes removing things they can’t fathom but assume were put there for a good reason.
This assumption is often wrong. It is in your gift to change it. You just need to take hearts and minds with you.
A useful rhetorical, seldom posed, is:
If someone presented this term to me, would I accept it?
If not, do not be surprised when customers do not accept it and you have to change it.
Rebase your documents to be acceptable to the person on the Clapham omnibus, at least in concept, from the off. Legal advisors are anyway incentivised to seek changes as a means of demonstrating their value. Why start with a form with which any sane advisor would have to take issue?
Your legal documents are your weapon of last resort when all other defence mechanism have failed.
“Platinum plating”
Pareto’s law tells us a few special, “platinum” customers will generate outsized revenues while the large majority will generate acceptable but unremarkable returns. A common gambit here is a sort of “quality triage” whereby the firm offers “platinum” customers more favourable terms than everyone else. Some firms even “tier” their customers, offering softer starting points for platinum customers.
In that it implies legal wrangling is a sort of penalty for insignificance, this is madness. That is not the reason your firm negotiates legal terms. Indeed, it is to put things precisely backward: platinum customers generate that juicy revenue by taking more risks with more of the bank’s money. Platinum customers leave a much bigger crater when they blow up.
When we tell war stories about crisis closeouts from the good old days, no one talks that time a two person shop operating out of a flat above a chip shop in Putney went bust. They talk about LTCM, Enron, Madoff, Melvin and Archegos. Platinum clients: precisely the customers with whom your legal agreements should be strongest.
The converse is this: if your platinum client documentation is fit for managing your riskiest clients, then it is fit for everyone else too.
You don’t need need to tier your clients: just offer them all the better terms. The purpose of legal documentation is sometimes opaque but it is not punishment. Offering “platinum terms” to regular customers will also reduce how much time you spend — waste — haggling with customers who present less risk and generate less revenue in the first place. Why burden your own onboarding process with performative negotiation with low-risk clients?
Nor does lowering your starting bid weaken your onward negotiating position. Swap dealing is not a zero-sum game. There are no points for securing stronger risk terms than you need — that does not translate to less risk, just more negotiation — and your walk-away point remains your walk-away point however close you start to it. The sooner you get to agreement, or your walkaway point, the better.
And if you are diligent, consistent and rigorous in this approach, your customers and their advisors will quickly figure this out. They will soon tire of running into a brick wall — your crack negotiation squad — for the sake of improving what is already a reasonable position.
Simplicity
All else being equal, make it simple. This, of course, depends on your counterpart: you can’t clap one-handed, and a dogged pettifogger who takes pride in convolution — there are many of these — will not be assuaged by your best efforts to be brief, however noble.
But Serenity’s Prayer is your friend, all the same. Sure; there are things you cannot change — bear them with good grace and a joyful heart — but just as many yet that you can: you may have to live with whatever pedantry is flung back to you but do not court it by needlessly complicating what you send out.
Convolution causes confusion. Confusion causes fear and requires explanation. Explanation leads — perhaps, eventually — to resolution, but takes time, burns resources, and comes at the cost of variance from your ideal. All this mucking around invites pedantry, should your counterparty’s advisers be given to pedantry. Lawyers, by nature, are given to pedantry.
In essence: having to explain something that could have been clear in the first place, without loss of emphasis is, at least, wasted energy.
Use plain language. Short sentences, modern language. Use “you must ~” rather than “Party B shall be obligated to ~”. Use “we may ~” rather than “Party A shall be entitled but, for the avoidance of doubt, not obliged to ~”.
Write agreeably. You have choices in how your institution expresses itself: these can influence the critical path of your negotiation. Don’t poke your customer with a sharpened stick. Take lessons from Dale Carnegie: try to win friends and influence people. There are polite, agreeable and damnable ways of saying the same thing.
Compare:
“Customer shall be obliged forthwith upon demand and from time to time unconditionally to indemnify and hold the Bank harmless, without set-off, limitation or counterclaim, in the event the Bank or any one or more of its affiliates, agents, nominees or sub-custodians, howsoever described, suffers or incurs, or determines in its absolute discretion that it is or may be likely to suffer or incur, any custom, duty, excise, taxation, stamp or withholding, levy, deduction or charge of whatsoever nature, including penalties, costs, charges and legal expenses incurred in respect thereof, with regard to or in respect of any of Customer’s assets held by or in the name of or in the custody network of the Bank in connection with this Agreement or otherwise.”
with:
“If we incur any tax while looking after your assets for you, you must reimburse us upon request.”
Simplicity aids comprehension when things are going to hell.
Almost all the tools you need are in the pre-printed Master Agreement. It bears repeating that, in these days of daily variation margin, it will be a rare day when your only option to close out a loss-making ISDA will be a NAV trigger or a key person clause.
What you can do about it
“This is all very well, JC, but come on. What hope have I, a mere subject matter expert, of influencing an organisation’s sacred forms? Hell will surely first freeze over.”
It is only a truism that nothing is more immutable than policy if — because — no-one ever challenges it.
Who should bell the cat?
Who better than she who must suffer under its yoke?
Pray, forgive JC’s mixed-metaphor rabble-rousing — but is not that challenge the very thing you have to offer? Is it not your calling? Your destiny? Your superpower?
Within your gift, if only you would give it, lies the fresh air to heal the wounds and scars of historical misadventure to which those templates bear gruesome witness. And if you won’t speak up, why not? What does that then say about your life’s work? That you are but a painted ship upon a painted ocean?
Try it! Go on! Offer to fix your doughty verbiage! What have you got to lose? Did anyone get fired at your firm for asking reasonable questions? If they did, why are you still working there?
Of course, your counterparty’s negotiators will be just as institutionalised. They, too, will expect a certain form. They will fear, just as you do, stepping away from What Is Written; for departure from that which can be done without fear of blame. The buttocractic oath is a strong incentive. But overcome it!
Rise up, subject matter experts! Slip your surly bonds!
A word from Mr Nietzsche:
“For believe me! — the secret for harvesting from existence the greatest fruitfulness and the greatest enjoyment is: to live dangerously! Build your cities on the slopes of Vesuvius! Send your ships into uncharted seas! Live at war with your peers and yourselves! Be robbers and conquerors as long as you cannot be rulers and possessors, you seekers of knowledge! Soon the age will be past when you could be content to live hidden in forests like shy deer!”
JC’s anecdotal evidence is that suspicion of simpler forms quickly gives way to relief. If you get your design right, your customers will quickly see the advantage. Negotiators have enough of a job thrashing through everyone else’s ghastly forms: they will be glad of the relief you offer with an easy one.
If you don’t ask, you won’t get.