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Legal considerations when managing counterparty credit risk in OTC derivatives

Edward Miller, Partner and Sarah Reid, Associate, Derivatives and Structured Finance Group, Field Fisher Waterhouse


Abstract
This article analyses the main legal considerations for a party trading over-the-counter (OTC) derivatives transactions in the context of managing its counterparty credit risk. The article looks at netting and collateral as key mitigants to counterparty credit risk. Each mitigant is examined in the context of normal trading conditions as well as following a default by a counterparty or the insolvency of a counterparty. As the subject of the article is OTC derivatives, its analysis centres on the suite of industry-standard legal documentation published by the International Swaps and Derivatives Association, Inc. (ISDA) which is almost universally used as the framework documentation for OTC derivatives.

Keywords
counterparty credit-risk, OTC derivatives, swaps, International Swaps and Derivatives Association, ISDA, netting, collateral


Edward Miller is a partner in the Derivatives & Structured Finance Group at Field Fisher Waterhouse LLP, having been with this Group since 1996 and a partner since 2003. Edward graduated from the University of Oxford in 1991 and from the College of Law in 1994. He is a Solicitor of the Senior Courts of England and Wales. He has specialised in derivatives, repos and stock lending for many years, together with structured finance transactions. Edward advises in particular on netting and collateral issues in derivatives — including central clearing of OTCs and triparty repo. He is a member of various International Swaps and Derivatives Association, Inc. (ISDA) working groups. Edward is lead author of FFW’s highly acclaimed Summary of ISDA Legal Opinions on Close-Out Netting, which is widely regarded as the standard guide in the market on this subject.

Sarah Reid is an associate in the Derivatives & Structured Finance Group at Field Fisher Waterhouse LLP, having been with this Group since 2008. Sarah graduated from the University of Oxford in 2003 and from BPP Law School in London in 2006. She is a Solicitor of the Senior Courts of England and Wales. Sarah advises a wide range of clients on derivatives, repos and stock lending, as well as triparty collateral arrangements and prime brokerage agreements. Sarah has spent periods of time on secondment to the London offices of two US broker–dealers.


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