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6 Harv. Negotiation L. Rev. 211
Harvard Negotiation Law Review
Spring 2001
Student Article
THE RISE OF A TRADE ASSOCIATION: GROUP INTERACTIONS WITHIN THE INTERNATIONAL SWAPS
AND DERIVATIVES ASSOCIATION
Sean M. Flanagand1
Copyright (c) 2001 Harvard Negotiation Law Review; Sean M. Flanagan
Table of Contents
I.
II.
III.
IV.
INTRODUCTION
DERIVATIVES
A. OVERVIEW OF DERIVATIVES
B. TYPES OF DERIVATIVES
1. Forwards
2. Futures
3. Options
4. Swaps
5. Other Instruments
C. A HIGH-STAKES INDUSTRY
1. Barings
2. Procter & Gamble
THE FUNCTION AND EVOLUTION OF ISDA
A. ISDA’S FUNCTIONS
B. STANDARD FORM DOCUMENTATION
1. ISDA Master Agreements
2. Netting Opinions
3. Definition Booklets
C. FORMATION: 1984 TO 1985
1. Beginnings
2. ISDA
D. DEVELOPMENT: LATE 1980S TO MID-1990S
1. Growth
2. Committees
3. The ISDA Master Agreement
4. An Expansion of Scope
E. TRANSFORMATION: MID-1990S TO 2001
1. Changing the Model
2. Current Drafting Processes
3. A New Type of Challenge: Master Masters
LESSONS FROM ISDA
A. INDUSTRY RELATIONS
1. A Concentration of Negotiations
2. Stakes
3. Taking Advantage of Success
© 2011 Thomson Reuters. No claim to original U.S. Government Works.
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V.
B. ORGANIZATIONAL CONTROL
1. Formality and Flexibility
2. Shifting Gears
3. Institutional Memory
C. DRAFTING COMMITTEES
1. Goals
2. Players
3. Framing
4. Drafting Documents that Last
a. Never Compromise on Quality
b. Process is Key
c. Remember the Big Picture
d. Get Down to Fundamentals
e. Education
CONCLUSION
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*212 I. Introduction
This article presents a case study of the International Swaps and Derivatives Association, Inc. (‘ISDA‘). ISDA is the trade
association for dealers and other participants in the over-the-counter derivatives markets. Over-the-counter derivatives are a
diverse class of financial instruments useful both for hedging financial risks and for speculation. 1
*213 This case study has two primary goals. First, it endeavors to make the details of ISDA’s development available to the
business and academic communities. ISDA has been a remarkably successful trade association; similar organizations and
scholars may find its experiences instructive. Second, the study attempts to distill lessons from ISDA’s successes that may
apply to trade associations, joint ventures, nonprofit organizations, businesses, legal work, and multiparty negotiations.
The study comprises five sections. Following this first introductory section, Section II presents a sketch of the standard types
of derivative instruments for the benefit of the financial novice. Its goal is to provide the reader with a basic idea of what
derivatives are, what purposes they serve, and what is at stake for participants in the derivatives industry. Section III presents
the history of ISDA from its formation in the mid-1980s to the present. This section looks at the services ISDA provides and
the types of standardized documentation ISDA has developed with the participation of its members. The section also analyzes
the control structures and internal negotiation processes within ISDA, particularly those relating to the development of
standardized documentation. The discussions will highlight the methods ISDA uses to develop a consensus among its
members regarding appropriate industry documentation standards. Finally, Section III also examines the changing roles of
the organization’s board of directors, staff, and outside counsel over the course of ISDA’s life. It provides analyses of several
specific occurrences in the history of ISDA, including the drafting of the SWAPS Code, the writing of the 1987 ISDA Master
Agreement, and the current debate over “master master” agreements. Section IV draws some lessons from ISDA’s
experiences. This section particularly focuses on ISDA’s successes in unifying a young industry, developing an effective
committee-based process for establishing industry standards, and redesigning its control structures to accommodate changes
within the organization and in the industry. An analysis of the means by which ISDA accomplished these goals should be
helpful to organizations, scholars, lawyers, and negotiators involved in structuring multiparty negotiations. Section V offers
some conclusions and implications inferred from the previous analyses.
*214 II. Derivatives
A. Overview of Derivatives
Derivatives form a diverse class of financial instruments, which includes forwards, futures, options, and swaps. 2 These
instruments have developed a reputation for complexity and for causing financial disasters. 3 They are, however, actually
quite simple in their most basic forms; the more complex versions merely mix and match these basic forms. Despite the role
derivatives have played in a number of financial catastrophes, such as the bankruptcy of Barings (the oldest merchant bank in
England)4 and the derivatives losses suffered by Procter & Gamble in 1994, 5 derivatives more often serve to reduce--rather
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than to increase--financial risks for their users.6
Derivatives take their name from the fact that they “derive” their value from some other underlying asset. For example, a
share of common stock, which is not a derivative, has value because it is an ownership interest in a corporation. However, an
option, which gives the owner the right--but not the obligation--to buy that share of stock, is a derivative. The option
“derives” its value from the value of the share of stock. If, for instance, at the exercise date of the option, the option contract
states that the holder may purchase a share of common stock for $5, and the market price of the stock is $6, the option is
worth $1 because it gives the option-holder the right to buy something worth $6 for $5, a $1 savings. On the other hand, if the
market price of the stock were $4, the option would expire worthless because the holder would not want to buy something
worth $4 at a price of $5. In either case, the value of the option “derives” its worth from the value of something else.
*215 There are four basic types of derivatives: forwards, futures, options, and swaps. Some are standardized and easily
fungible with one another7--e.g., the futures and options on the Chicago Mercantile Exchange and the Chicago Board of
Trade.8 Others, referred to as “over-the-counter” (OTC) derivatives, are individually negotiated between a dealer and a
customer (as opposed to purchased in standardized form on an exchange), with terms tailored to the specific needs of the
parties.9 Dealers in OTC derivatives comprise ISDA’s primary membership. 10
The basic derivatives, their histories, their uses, and their standardized and OTC forms are discussed below. As stated in the
introduction, this discussion is very basic and will probably not be useful to a reader already familiar with derivatives. It is
intended to provide the reader with a sense of how derivatives work and why they are important financial tools. In addition,
the section provides background knowledge that will allow the reader to appreciate the significance of ISDA’s documentation
activities to industry participants.
B. Types of Derivatives
1. Forwards
A forward, also known as a “forward contract,” is simply a contract that will not be performed until a specific date in the
future.11 For instance, a farmer may make a contract today (as he is planting his crop) to sell a certain amount of wheat at a
certain price--the “contract price”--to a baker in six months’ time (at which point he will have harvested his crop). The farmer
is contractually obligated to deliver the wheat in six months’ time, and the baker is obligated to pay the farmer the contract
price in six months’ time, regardless of the actual market price for wheat at the time of the exchange. The farmer is happy
with this arrangement because the forward guarantees him the contract price, even if the market price falls over the next six
months.12 The baker is happy because the forward guarantees that he will pay only the contract price, even if the market price
*216 for wheat rises over the next six months. Both parties have eliminated the risk of an unfavorable change in the market
price of wheat. This is a simple forward contract.
Forward contracts have been around for centuries. Forward contracts were written in England at the Royal Exchange as early
as the 1630s,13 and forwards for commodities such as grain have been written in the U.S. since the mid-nineteenth century.14
Today, forwards are used for numerous purposes, including contracting for commodities, financial assets, and interest rates. 15
As the illustration with the farmer and the baker demonstrates, businesses can use forward contracts to manage certain types
of risk. In the above example, the risk was that wheat prices would change unfavorably. Suppose the farmer also knows he
will need a loan to buy new farm equipment in nine months, but is afraid that interest rates might rise. In that case, he can
enter into a forward contract with a bank. Both the farmer and the bank are then protected against adverse changes in the
interest rate market (the farmer from an increase and the bank from a decrease). In nine months, both parties will be obligated
to complete the loan at the agreed-upon rate, regardless of the change in market interest rates. Just as the contract between the
farmer and the baker becomes more valuable to the baker if the market price of wheat rises, so the contract between the
farmer and the bank becomes more valuable to the bank as market interest rates fall.
The ability to manage risk with forward contracts can be beneficial to businesses. The farmer is in the business of growing,
harvesting, and selling wheat. He is not in the business of gambling on changes in the price of the wheat that he sells. The
baker is in the business of making and selling bread. He is not in the business of gambling on the price of the wheat that he
must buy to make his bread. If they do not make a forward contract and the price moves in either direction over the next six
months, one of these two businessmen will benefit from a windfall, and the other will take an unexpected loss. With the
forward contract, both lock in the price they will respectively receive or pay for the wheat in six months’ time and can make
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their business plans accordingly. Protecting against risk in this way can improve a business’s creditworthiness in the eyes of
lenders.16
*217 2. Futures
Futures are almost identical to forwards; the former are standardized versions of the latter. 17 Futures have been in existence
since standardized rice contracts were first sold and traded in Japan in the seventeenth century. 18 Because futures in a specific
commodity are standardized as to amount and type of the underlying asset, maturity dates, payment methods, and delivery
terms, futures are fungible with one another. 19 This allows futures to be traded on exchanges like shares of common stock. 20
Unlike forward contracts, which are directly negotiated between end-users, futures are bought and sold on an exchange. A
clearinghouse acts as a middleman between parties who would otherwise have to contract directly with one another.21
A wheat future purchased on an exchange represents the obligation to buy a certain standardized amount of wheat at a certain
moment in the future. Returning to the illustration of the farmer and the baker, the farmer could go to an exchange and sell
wheat futures that mature in six months instead of directly entering into a forward contract with the baker. The futures would
oblige the farmer to sell his wheat at the end of those six months. The baker could buy futures that give him the right to buy
the amount of wheat he desired at the end of the six months. The clearinghouse would act as the middleman connecting the
two.
Unlike forward contracts, futures are rarely actually settled with the commodity from which they derive their value. 22
Instead, they are generally settled with cash. If the farmer sold futures that give him the right to sell his wheat for a total of
$100,000, and the market price of that wheat at the end of the six months is only $80,000, the baker pays the farmer $20,000
through the clearing house. The farmer then sells his wheat on the market for $80,000. Between the sale price of his wheat
and the $20,000 payment, the farmer grosses the $100,000 he had ensured himself by selling the futures. The baker, after
paying the farmer $20,000, buys wheat on the market for $80,000. Between the market price and the payment to the farmer,
he has spent the $100,000 that he had ensured himself by buying the *218 futures. If the market price had moved an equal
amount in the other direction, the flow of payments would be reversed.
Thus, futures allow the same type of risk management, or “hedging,” that forwards do. However, hedging through futures has
fewer transaction costs than hedging through forwards because the terms of the contract are standard and need not be
negotiated, and the parties do not have to locate each other since they merely go to the exchange. In addition, since futures
are traded on exchanges, the holder of a valuable future may choose to lock in his gain by selling an off-setting contract on
the exchange. The primary drawback of futures as a hedging tool is that, because of their standardization as to maturity date
and amount of underlying asset, futures contracts will be unlikely to provide as exact a hedge as a carefully tailored forward
contract.23
As with forwards, businesses in numerous industries use futures. Futures cover many types of commodities, including oil,
interest rates, currency, raw materials, and various agricultural products.24
3. Options
Like futures and forwards, options involve contractual obligations to be performed at a specific date or dates in the future, but
the holder of an option has a right, rather than an obligation, to exercise the contract. As a result, an option holder will not
exercise his contract rights unless the contract is beneficial to him (known as being “in the money”).25 For instance, if the
farmer bought a six-month option to sell wheat at $100,000 (known as “a put”), and the market price at the end of the six
months were $120,000, the farmer would most likely not exercise the option. Instead, he would sell his wheat on the market
and keep the entire $120,000 sale price. If the baker purchased a similar six-month option to buy wheat at $100,000 (known
as “a call”), and if the price were $120,000 at the end of the six months, the baker would be likely to exercise the option. As
with futures, the baker would obtain cash for the difference between the market price and the option price. He would receive
$20,000 from the “writer” who sold the option and then would buy wheat on the market for $120,000. Thus, options derive
their name from the fact that they *219 give the holder the “option” of having a contract with certain terms at some point in
the future.
Like forwards and futures, options have a long history. Tulip-bulb options were sold in Holland in the early seventeenth
century and puts and calls on shares of stock were being traded on the London Stock Exchange by the early nineteenth
century.26 Options trading exploded in the United States in the 1970s, after Fischer Black and Myron Scholes introduced
their Nobel-Prize-winning option-pricing formula. The formula allowed writers of options to scientifically price their
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products--a task that had been a risky art beforehand.27
Like futures, certain types of options are traded on exchanges. Unlike futures, which can be settled at maturity only, most
options sold on exchanges in the United States may be exercised at any point between purchase and the end of the option’s
life, the “expiry date.”28 These options are known as ‘American options.‘ Options that may only be exercised on their expiry
date are known as ‘European options.‘29 Thus, if a wheat shortage causes a spike in wheat prices four months into a
six-month option, the baker may (if he is holding an American option) exercise his option to buy at $100,000 two months
early, pocket a large cash settlement, and buy his wheat on the market two months later when prices have returned to normal.
If the baker were holding a European option (which, despite its name, is widely available in the United States and is
particularly common in the OTC markets),30 he could realize a similar profit by entering into an offsetting contract with the
exchange.31
Writers of options make money by charging an upfront “premium” for each option.32 This is necessary because, unlike
futures, in which the losing party pays the counterparty at maturity, the holder of a losing option does not have to pay the
writer anything at maturity. If prices are stable, option holders will rarely collect more money than the premium, leaving the
writer ahead in the transaction. If *220 prices are volatile, however, option writers may suffer devastating losses. 33 The
option holders are happy paying the premium because they know that, unlike with a forward or future, their potential loss on
the option is limited to the upfront amount they paid for it.
Some options are not standardized or traded on exchanges. These OTC options must be privately negotiated with a dealer.
Both OTC and exchange-traded options can serve the same hedging purposes as forwards and futures.
4. Swaps
In essence, swaps are a series of forward contracts strung together. In a swap, two parties agree to exchange cash flows based
on some underlying index and on a “notional” amount of an asset.34 Unlike futures and most options, swaps are always
privately negotiated OTC derivatives and are not traded on exchanges. 35
In a swap, two parties in effect agree to carry out a series of transactions with one another at regular intervals and over a long
period. Unlike forwards, futures, and options, which rarely cover periods longer than 12 months, swaps usually cover periods
of years.36 For example, the farmer and the baker can enter into a swap agreement if they want to guarantee themselves a
certain price for wheat over a long period. To do so, they must agree on several things. First, they must settle on an amount of
wheat (the “notional” amount) and a contract price, the standard factors in a forward contract. Next, they must specify a
mutually agreeable price index, which they will consult periodically to determine the then-current market price for the
commodity. Finally, they must determine how often and for how many years they want to exchange the notional amount of
wheat. For instance, they might decide to exchange the notional amount of *221 wheat at a contract price of $100,000 once
every six months for the next five years. These are the basic elements of a swap agreement.
Once the swap is set in motion, each party repeatedly pays a certain amount to the other party. In this case, every six months
for the next five years, the baker pays the farmer $100,000--the contract price. In turn, the farmer pays the baker the current
market price for the notional amount of wheat--the monetary equivalent of actually delivering the wheat. The amounts owed
by the parties are netted so that only one party actually makes a payment.37 Thus, if the market price of wheat stays the same
for the first six months, the baker owes the farmer $100,000, and the farmer owes the baker $100,000, so the net payment is
$0 on the first payment date. If the market price rises to $120,000 over the second six-month period, the baker owes the
farmer $100,000, and the farmer owes the baker $120,000, so the farmer makes a net payment of $20,000 to the baker. 38 If
prices continue to rise for the entire five-year term of the swap, the farmer loses on the contract and pays the baker every six
months. Presumably, before entering into the contract, the farmer calculated that his business could be successful for the next
five years selling wheat at the $100,000 price level. 39 By engaging in this transaction, the farmer has protected himself from
a price collapse, so the contract has value to the farmer even if he is the one who consistently pays. Meanwhile, the baker has
been able to stick to his original business plan because he was prepared for the price increase in wheat.
In practice, the swap between the farmer and the baker would likely include a third party: the dealer. 40 The dealer is a large
financial institution, such as a bank or securities firm, that acts as a middleman in transactions of this sort. The farmer can go
to the swap dealer and negotiate terms identical to those discussed above. 41 The only difference for the farmer is that the
other party to the swap is the dealer rather than the baker. The farmer would probably find value in this because he would run
less risk of his counterparty going bankrupt and failing to live up to its end of the swap; the dealer is a *222 much more
dependable counterparty than the baker is. Like a bookmaker balancing out bets, the dealer then can protect himself against a
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change in the price of wheat either by hedging with exchange-traded futures or else by entering into a swap opposite to its
swap with the farmer.42 For instance, he can enter into a swap with the baker. Thus, if wheat prices rise, the farmer pays the
dealer. The dealer, who owes the baker on the other swap, in effect passes the farmer’s payment on to the baker minus a
small cut (the bid-ask spread maintained by the dealer).43 If prices fall, the payment stream is reversed, but the dealer still
profits on the spread. These dealers make up the majority of ISDA’s Primary Membership. 44 (ISDA, in fact, was named the
International Swap Dealers’ Association from its creation until 1993 when it changed to “Swaps and Derivatives.”)45
Swaps are used in many industries. The swap between the farmer and the baker is an example of a commodity swap. The
most common type of commodity swap is based on oil and is used by parties such as airline companies and oil producers. 46
The most common swaps, however, are not in commodities. Rather, the majority of swaps, both in number of contracts and
aggregate size of notional amounts, consists of interest-rate swaps.47 In interest rate swaps, one party pays the other a fixed
interest rate on a notional amount of money (e.g., 5% APR on $100,000). The other party pays a floating interest rate on the
notional amount (e.g., LIBOR + 2% on $100,000). 48 Like the price of wheat, the floating interest rate is based on an index
and changes over time. The most common index used is LIBOR (the London Interbank Offered Rate), which is the interest
rate at which London banks loan each other money.49 Interest-rate swaps are useful for banks with income at a fixed
percentage rate--e.g., long-term fixed mortgage payments--and expenses at floating rates--e.g., interest payments to
depositors. *223 A rise in interest rates could bump a bank’s floating expenses higher than its fixed income. To protect
themselves, banks such as these can enter into interest-rate swaps.50 The banks pay the dealer a fixed rate of interest on a
notional amount (which they know they can pay while still making a profit, based on their fixed amount of mortgage
income). The dealer then pays them a floating rate in exchange for their fixed rate. If interest rates fall, the bank pays the
dealer a net amount based on the fixed interest rate but still makes a profit over its fixed mortgage income. If interest rates
rise, the higher floating rate payments from the dealer offset the higher payments the bank must make to its depositors. 51
Interest rate swaps make up both the largest number and highest dollar values of swaps handled by ISDA members,
according to ISDA’s most recent full breakdown of the market. 52
Swaps are some of the newer types of derivatives in the market. Some simple swap-like agreements were developed in the
late seventies to bypass certain United Kingdom currency restrictions, 53 but the first swap agreement to attract the financial
world’s attention was signed between IBM and the World Bank in 1981. 54 In that swap, the bankers acted merely as
matchmakers, setting up the equivalent of a direct farmer-baker swap with no middleman.55 The market has grown
exponentially since then. Financial institutions switched roles from matchmakers to middlemen (dealers) during the 1980s. 56
A group of these early swap dealers founded ISDA. 57
5. Other Instruments
Lawyers and swap dealers have tweaked and combined the four basic forms of derivatives discussed above to produce a wide
array of instruments. These include such exotic-sounding derivatives as accreting principal swaps, exploding options, kitchen
sink bonds, swaptions, and leveraged inverse floating-rate notes.58 Most of these *224 instruments use the above-described
derivatives as bases and then add features that vary the payoffs in unusual ways. For instance, a “leveraged swap” can be
structured so that the losing party has to pay two or three times the difference between the contract price and the market
price.59 In an “inverse floating-rate note,” a debt security with an imbedded interest-rate swap is structured so that the
floating rate paid to an investor moves inversely to the interest rate in the index. 60 A “swaption” mixes swaps and options,
creating an option to enter into a future swap. 61
C. A High-Stakes Industry
As was mentioned at the beginning of this section and as was demonstrated by the accompanying examples, derivatives are
excellent tools for reducing and managing risk. Derivatives are also, however, extremely effective tools for taking market
positions.62 This is particularly true of certain structured or complex derivatives, such as the leveraged swaps mentioned
briefly in Part II.B.5, supra. As with any investment with a high payoff, though, derivatives of this sort can be extremely
risky as well. When a speculative investment such as a leveraged swap does not pay off, the speculator can suffer substantial
losses. Some high-profile cases combined with a poor understanding of derivatives themselves have given derivatives a bad
reputation among some investors, regulators, and business operators. 63 Discussed below are Barings and Procter & Gamble,
two cases that serve to illustrate how derivatives can cause large losses if misused. The Barings case involved standardized
exchange-traded derivatives, which are not the realm of ISDA and its membership. Procter & Gamble, however, did involve
OTC derivatives. This case demonstrates to the reader some of the risks that dealers and end-users in the OTC derivatives
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industry face. These risks underlie the importance of ISDA’s role of setting industry standards, educating industry *225
participants, and developing standardized, legally sound documentation.
1. Barings
Barings was the oldest merchant bank in the United Kingdom. 64 It funded the Louisiana Purchase.65 Early in 1995, a single
trader in Barings’ Singapore office, Nick Leeson, bankrupted the entire institution by trading in exchange-traded
derivatives--specifically, speculative option-writing. In the course of approximately two months, he racked up losses of over
a billion dollars, more than two-and-a-half times the bank’s stated capital.66
Leeson managed to do this by trading in the bank’s name secretly through an account labeled “error account 88888.” Leeson,
who had been viewed as a “wonder boy” by his superiors at the bank, had been reporting huge but fictitious gains for three
years by hiding his speculative trading losses in his secret account and reporting gains in his official account.67
His speculation finally caught up with him when an earthquake in Japan caused the Nikkei index to plunge. In turn, this
plunge caused the thousands of options tied to the Nikkei index that Leeson had been writing on behalf of Barings to take
enormous losses. He secretly tried for two months to make back the massive but still hidden losses with increasingly riskier
derivative instruments until the losses mounted to well over a billion dollars. Consequently, the bank found itself in
receivership overnight.68
Understandably, events such as this one terrify financial institutions. Post-mortem analyses indicate that what brought
Barings down was not a flaw in the derivative instruments themselves, but poor internal controls and management
supervision.69 Management had ample warning, including large funding requests from Leeson, discoveries of discrepancies
by outside auditors, market rumors made known to Barings, and the unusually high reported profitability of Leeson’s trading
activities relative to the level of risk which Leeson was authorized to take by Barings.70 Such high payoffs, if in fact real,
*226 should have warned Leeson’s superiors that there was a risk of equally great losses.71
2. Procter & Gamble
Although the Barings bankruptcy involved exchange-traded derivatives, rather than OTC derivatives,72 OTC derivatives have
played a role in some other high-profile derivatives-related losses. Procter & Gamble is one such case.
In 1994, Procter & Gamble announced losses of $157 million on its derivatives transactions. 73 Procter & Gamble had entered
into two complex and highly leveraged swaps with Bankers Trust, 74 an OTC derivatives dealer and one of the founding
members of ISDA.75 The swaps were very sensitive to fluctuations in interest rates and foreign exchange rates. 76 When these
rates moved unfavorably in relation to Procter & Gamble’s position, the company’s payment obligations under the swaps
became enormous.77
Procter & Gamble attempted to avoid its payment obligations under the swaps by filing suit and claiming, among other
things, that Bankers Trust owed Procter & Gamble fiduciary duties stemming from the dealer’s role as the seller of a
custom-made derivatives package. Procter & Gamble claimed it did not fully understand the swaps and that it relied on
Bankers Trust to tailor the swaps to fit the company’s needs. 78 The court granted summary judgment against Procter &
Gamble on the fiduciary issue, emphasizing that the parties had contracted at arm’s length and generally rejecting the
possibility of fiduciary relationships between parties to a business relationship.79
*227 This case and others like it, such as Gibson Greetings,80 led to concerns among OTC derivatives dealers that their
counterparties could escape liability under losing swaps by claiming that the dealer owed them various duties and had, in
essence, breached those duties by selling the counterparty a swap under which it lost money. 81
Derivative disasters such as Barings and Procter & Gamble highlight some of the challenges ISDA and its members face:
large market participants can and do go bankrupt; disgruntled counterparties will challenge contracts in court; and regulators
will become involved when problems arise. ISDA addressed and continues to address these problems through efforts to
improve documentation, reduce or eliminate legal risks, develop protections against counterparty bankruptcy, maintain good
industry relationships with regulators, and respond to regulators’ concerns.
III. The Function and Evolution of ISDA
This section describes the formation and development of ISDA and analyzes the evolution of its internal decision-making
processes. It focuses on the documentation standardization projects that have occurred over the course of ISDA’s life. These
projects provide an excellent context in which to study the dynamics of the organization.
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The analysis is divided into five parts. The first section introduces ISDA’s basic functions. The second part presents a
detailed description of several of the standardized documents that ISDA has produced. The remaining sections present a
chronological analysis of ISDA’s history, focusing separately on its formation in the mid-1980s, its development during the
late 1980s and early 1990s, and the changes it underwent starting in the mid-1990s. The analysis in these three parts
examines the way in which ISDA’s structures for handling internal negotiations and decision-making have changed over
time. Special attention is paid to the changing roles of the board of directors, committees, staff, and outside counsel. These
changes are illustrated with details of specific projects from each period.
*228 A. ISDA’s Functions
The International Swaps and Derivatives Association, Inc., is a trade association for OTC derivatives dealers and other
market-participants. The majority of ISDA’s activities focuses on the market for privately negotiated swaps contracts. 82 As is
discussed in Parts C, D, and E of this section, both ISDA and the OTC derivatives industry have grown exponentially since
the early days of the industry and the foundation of ISDA in the mid-1980s.
As of January 2001, ISDA has over 500 member organizations; more than 200 of these are Primary Members, 83 about 160
are Associate Members,84 and over 130 are Subscribers.85 The Primary Membership is composed of dealers and
encompasses banks, securities companies, and large corporations from over thirty countries, including institutions such as
Barclays; Chase Manhattan Bank; Credit Suisse First Boston International; Deutsche Bank AG; Enron Corporation;
Sumitomo Bank Capital Markets, Inc.; and Merrill Lynch & Co., Inc. 86 The Associate Membership includes diverse
professional firms and corporations such as Allen & Overy; the Chicago Mercantile Exchange; Cravath, Swaine & Moore;
Euroclear; KPMG Peat Marwick, L.L.P.; Standard & Poor’s; and QT Software AG. 87 Subscribers include end-users of
derivatives such as the African Development Bank; British Petroleum Company, P.L.C.; Ford Motor Credit Company; IBM
Corporation; McDonald’s Corporation; the Kingdom of Belgium; and Soros Fund Management, L.L.C. 88
ISDA now employs a staff of twenty-three in the U.S., nine in London, and four in Tokyo. 89 In addition, a new office with a
staff of *229 two was opened in Singapore in October 2000.90 The board has twenty-three members, representing institutions
from Europe, Asia, Australia, and North America. 91
ISDA has about twenty active committees and task forces, including Accounting, Documentation, the Euro, Trading Practice,
Market Survey, Operations, Auto-Matching, Regulatory, Risk Management, Credit Derivatives, Credit Risk Capital,
Operational Risk Capital, Collateral, Tax, Energy and Developing Products, Equity Derivatives, Asia Pacific, Latin America,
and Eastern Europe.92 A number of active regional ISDA subcommittees, particularly in South Africa and Japan, have
developed as well.93
ISDA plays an active role in corresponding with and appearing before regulatory and legislative bodies in the U.S. and
abroad to promote the OTC derivatives industry and the interests of ISDA members. ISDA also plays an educational role by
conducting conferences around the world and by working with developing countries to help them structure their financial
markets to accommodate OTC derivatives trading.94
B. Standard Form Documentation
The initial goal--and one of the key accomplishments of ISDA--has been the development, drafting, and promulgation of
standard form documentation for the OTC derivatives industry. The best-known standard form contract developed by ISDA
is the “ISDA Master Agreement,” which is discussed further in Subsection 1, infra.
In addition to this contract, ISDA has developed definition booklets intended to accompany the ISDA Master Agreement,
some of which are tailored for use in transactions involving specific product markets and industry segments. ISDA has
developed documents to accompany various specialized transactions, such as those involving commodity, energy, equity,
foreign exchange (“FX”), currency, and *230 bullion derivatives. ISDA also has created tools designed to manage default
risk, such as standardized credit support documentation95 and collateral opinions.96
1. ISDA Master Agreements
The ISDA Master Agreement has seen two incarnations, the first of which was released in 1987 and the second of which was
released in 1992. These documents are referred to as the 1987 ISDA Master Agreement and the 1992 ISDA Master
Agreement. ISDA publishes a user’s guide for the 1992 Master Agreement in English, Spanish, Japanese, and Chinese. ISDA
also publishes unofficial translations of the agreement itself in Polish, Japanese, and Chinese. 97
What makes the ISDA Master Agreement a “master” agreement, rather than just a simple contract, is its ability to handle
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numerous transactions between its parties over a long period. Essentially, a master agreement sets up a relationship between
the two parties. It establishes all of the terms (representations and warranties, obligations, definitions, events of default, etc.)
that the parties would like to include in any future transactions between themselves. 98
Once a master agreement is signed, the documentation of future transactions between the two parties becomes relatively
simple. The parties need only exchange a “confirmation,” a mini-contract listing only what is being exchanged, at what price,
in what currency, and on what date, along with any desired variances for that specific transaction from the standard terms set
out in the master agreement. This confirmation is incorporated automatically into the master agreement, becoming a small
part of a large, single contract between the parties, which is governed by the general terms established in the master
agreement.99
An end-user corporation and a swap dealer may exchange large numbers of confirmations over the course of several years,
resulting *231 in hundreds of simultaneous swaps between the parties. Without a master agreement, these swaps would
require that the two parties exchange hundreds of payments at each swap payment date. The terms of the ISDA Master
Agreement, however, can provide for netting the payments among all transactions made under the agreement between the
parties (called “cross-transaction payment netting”).100 This reduces transaction costs since numerous swap payments are
incorporated into a single payment.
In addition, special “close-out netting” provisions apply in cases of default or bankruptcy by a party. 101 These allow the
non-defaulting party to calculate a single settlement amount by offsetting its scheduled future payment and delivery
obligations to the bankrupt party against the bankrupt party’s obligations to it. This prevents the bankruptcy receiver from
“cherry-picking” individual swap contracts, choosing to enforce only those swaps in which the bankrupt party is owed money
and refusing to honor those in which the bankrupt party owes its counterparties money. 102
With close-out netting, a party entering into numerous swaps with a counterparty will be at risk from default by its
counterparty only to the extent that the party is a net winner over all of its swaps with the counterparty. A net losing party
faces no risk of loss at all from a bankrupt counterparty since it is owed no net amount. Without close-out netting, however,
the party will stand to lose not just the net amount it might otherwise have been owed on the winning swaps but also all of
what it expected it would owe the bankrupt party on the losing swaps. For instance, assume A and B have a master agreement
encompassing ten swaps. A is the winner on half of the swaps and expects to receive $100 from B on those five swaps over
the remainder of their lives. B is the winner on the other half of the swaps and expects to receive $110 from A on those five
swaps over the remainder of their lives. If A went bankrupt and if A and B had an enforceable close-out netting provision in
their master agreement, B would only stand to lose the $10 net amount it expected to receive from A. If B went bankrupt, A
would not lose anything since it is owed nothing by B.103
*232 Without a close-out netting clause (or if the clause were unenforceable in A or B’s jurisdiction), the risks in a
bankruptcy would be quite different. If A went bankrupt, B would stand to lose not just the $10 net amount but also the $100
it owed A on A’s 5 winning swaps over the remainder of their lives since A’s receiver would cancel A’s five losing swaps
with B (eliminating A’s $110 debt to B) and “cherry-pick” A’s five winning swaps. Similarly, if B went bankrupt, A would
face paying $110 on cherry-picked swaps over the remainder of their lives to B’s receiver while receiving nothing in
return.104
As legal and regulatory issues arise that affect the ISDA Master Agreement and its usability in the market (such as previously
anticipated Year 2000 difficulties and the development of the European Economic and Monetary Union [[“EMU” ]) and as
new derivative products emerge, ISDA publishes standard amendments that may be incorporated into agreements to address
these problems. For instance, ISDA created an innovative web-based method for incorporating contract amendments to
accommodate the EMU. Parties to existing ISDA Master Agreements could automatically update their contracts to
accommodate the EMU if both parties registered their agreement to the amendment terms on ISDA’s website. Over 1,100
dealer and end-user firms agreed to this amendment over the web, thereby automatically incorporating amendments
addressing the currency change into ISDA Master Agreements existing between themselves and any of the other 1,100
firms.105
Benefits for the parties that result from the widespread use of the ISDA Master Agreement include a reduction in transaction
costs, lower legal fees, less legal risk, and reduced default risk. The transaction costs are reduced because the parties as a
whole make fewer payments. The legal fees are lower because there is less drafting and consequently fewer reviews of
contracts. The legal risk is less because the contract forms are carefully drafted and updated in response to litigation and
regulatory developments. The default risk is reduced because of close-out netting.
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Primarily, it is the dealers who realize these benefits. Dealers engage in a much higher volume of transactions than end-users,
so they gain more overall from the incremental transaction-cost savings. In addition, because swap dealers tend to have high
credit ratings,106 *233 end-users are less likely to need the protection of the close-out netting provisions.
2. Netting Opinions
As was mentioned in the above discussion of the ISDA Master Agreement, close-out netting is an extremely important tool to
protect parties against the ill effects of counterparty bankruptcy. The validity of the close-out netting provisions in a
bankruptcy context was not clearly established in most jurisdictions when the ISDA Master Agreement was first drafted.
There was a risk that close-out netting provisions would be found unenforceable, particularly in jurisdictions with strong
protections for bankrupt parties.107
ISDA has hired law firms around the world to research the potential enforceability of close-out netting in their jurisdictions.
The organization then makes the resulting legal opinions available to its members. 108 ISDA currently has legal opinions for
over thirty countries that it updates yearly to reflect new legislation and case law in each jurisdiction. 109 Favorable opinions
on netting are necessary because they enable banks subject to the capital guidelines of the Bank for International Settlements
(“BIS guidelines”) to rely on netting when regulatory capital is assessed in respect of their derivatives transactions. This
reduces the amount of capital the bank must hold to cover those transactions. 110 This makes the legal opinions an extremely
valuable resource for some of ISDA’s primary members, giving them both legal comfort and the ability to use funds actively
that otherwise would have been required to be held in reserve. 111 ISDA also has worked to get legislation passed in various
countries to explicitly recognize close-out netting provisions and has succeeded in so doing in the United States. 112
3. Definition Booklets
One of the documentation tasks that ISDA undertook early in its existence was the development of standard definitions for
terms used *234 in the industry. The initial result, completed in 1985, was the Code of Standard Wording, Assumptions, and
Provisions for Swaps, known as the “SWAPS Code.” This document was followed by updates and additions in 1986 and
1987 and a major revision in 1991, referred to as the 1991 ISDA Definitions. 113 This document primarily focused on defining
and standardizing certain methods of calculating swap payments. 114 Since 1991, most of the definitional work done by ISDA
has been focused on developing standard definition booklets aimed at certain segments of the OTC derivatives market. For
instance, ISDA has produced definition books for transactions involving bond options, bullion, commodities derivatives,
“FX” derivatives, currency derivatives, municipal counterparties, and credit derivatives. 115
This standardization of terms allows the industry to speak a common language, thus reducing the need to negotiate over the
basic definitions that underlie the terms of each transaction under an ISDA Master Agreement. 116 Standardization also
reduces what is known as “documentation basis risk.” Documentation basis risk is the risk that a transaction that, based on its
commercial terms (i.e., notional amount, interest rate, payment schedule, etc.), appears to be a good hedge for another
transaction will be a less perfect hedge due to differences in the underlying definitions of the terms.117
C. Formation: 1984 to 1985
1. Beginnings
ISDA began as an informal swap documentation project undertaken by eleven financial institutions in 1984. 118 In the early
1980s, swaps were still a novelty. Banks received large fees and substantial spreads for arranging interest-rate and currency
swaps between *235 large corporations, banks, and government entities.119 As swap mechanics were improved and swap
volume increased, the major financial institutions that handled swaps each developed their own standard form agreements,
which generally were structured as master agreements.120 Each swap dealer’s standard contract, including the definitions of
the terms used in the contract, was unique.
The result was that swaps with ostensibly identical terms differed depending on the individual who had negotiated the swap
and the dealer from which they came.121 In addition, when dealers traded with one another, substantial effort was required to
bridge the gaps between the two parties’ forms and definitions. Negotiation over these contract terms consumed large
amounts of time and effort.
Market participants fought about everything...not because their position was necessarily, or even arguably, more correct but,
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invariably, because that position was more familiar.... Few of the instructing institutions understood their forms well enough
to take a view on what could or could not be changed. Their representatives were sent out with instructions to resist change
for fear of undoing the magic of the documentation. As a result, what lawyers like to call a battle of the forms quickly
developed.122
In 1984, Salomon Brothers contacted ten other institutions involved in the swaps market and arranged a meeting. The agenda
was to discuss the development of documentation standards that would settle some of the issues that currently had to be
negotiated--often at great expense--for each swap deal. An initial attempt to draft a standard form contract failed when parties
involved in the process felt that the contract that was being developed too much resembled one participant’s own standard
form master agreement (most noticeably in typeface and layout). At this point, the group pooled its resources and retained the
law firm Cravath, Swaine & Moore (“Cravath”) to assist in drafting. Lawyers from Cravath attended the earliest meetings of
the group. Cravath remains ISDA’s primary United States outside counsel to the present day. 123
After the initial experience of failure, the parties generally assumed that the differences between the participants were too
great for a consensus to be reached about what an actual standard form *236 contract should look like. Instead, the group
decided to focus on developing standard definitions for terms commonly used in swap agreements. These definitions
included terms typically used in contracts and fallback provisions dictating actions in unforeseen circumstances.124 Initially,
this goal was intended to be the full extent of the group’s activities. 125
Jeffrey Golden, who worked on the SWAPS Code as outside counsel, notes that the SWAPS Code contained most of the
ingredients of a contract. These ingredients, such as standard representations and warranties, default terms, consequences of
default, etc., were presented in menu format rather than in a form recognizable as a complete contract. Golden observes that
this helped the participants in the drafting meetings focus on substance rather than on form. The unusual menu format
avoided the negative visceral reactions that greeted the initial attempt at developing a contract. None of the participants
thought, “This contract looks more like their standard form than ours,” because it did not resemble anybody’s contract.
Instead, the parties negotiating over the definitions were faced with each term in isolation with no coherent relation to the
others. This approach helped the participants take a step back from the emotional battle of forms they had been engaging in
for years and focus on the merit of each definition. 126
A committee of about 25 representatives from the eleven institutions was formed to work on developing the definitions.
These representatives included bankers, traders, in-house counsel, and outside counsel.127 The mix of participants provided
the diversity of financial, legal, and practical expertise essential to developing robust documentation that would withstand the
scrutiny of courts and the market. At documentation committee meetings, generally held in the offices of *237 member
institutions or outside counsel, the members discussed each definition as a group, sharing their personal and institutional
opinions regarding appropriate standards and their experience with the issues involved. 128
Generally, each point was discussed by the group until a consensus was reached. The Cravath lawyers would try to capture
the consensus in a draft definition, which then would be circulated among the group members for comment and discussion
before being redrafted. The discussion, draft, comment, and redraft processes often were repeated several times for each
definition.129 This openness was one of the keys to the success of the process. Golden notes, “This was not a process where
lawyers go off into a corner and decide what is right, then try to force it on the market.”130 By constantly circulating drafts,
responding to comments, and demanding a consensus, the drafters of the definitions ensured acceptance and faith by the
market even before the definitions were complete.
When significant differences of opinion existed on the committee and consensus was not readily reached, the issue would be
left to “float” without a push for an immediate resolution. 131 Rick Grove, the Executive Director of ISDA from 1997 to
January 2001, notes that policy disagreements have always been common in the organization.132 Successful resolution of
such disagreements has been one of ISDA’s key functions. Postponing the settlement of these contentious issues often
resulted in a consensus developing on the issue at a later date through off-line discussions, compromise, and changing
perspectives as the entire package of definitions took shape. 133
Issues that remained contentious often could be resolved at the drafting stage. The outside counsel facilitating the drafting
process prepared a compromise definition that met each party’s interests. Alternatively, the definition was structured such
that it included a menu of alternate standard definitions from which the contracting parties could choose, thereby avoiding
resolution of the issue but allowing contracting parties to select for themselves. 134
*238 The process of negotiating and drafting standard documentation that the documentation committee developed as it
created these definitions has become the standard documentation process for ISDA projects. Long-term involvement by
outside counsel, directors, and full-time staff has ensured that ISDA’s institutional expertise in managing the process of
documentation development has been preserved and refined. 135
As the definitions project neared completion, the members of the group decided that they wanted to copyright the definitions
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and needed some sort of official entity to release the document and hold the copyright. The result was ISDA, the International
Swaps Dealers Association,136 which was formally created as a nonprofit corporation in 1985.137
ISDA released the final definitions in 1985.138 While not technically a contract, the SWAPS Code provided most of the key
building blocks for a contract and ensured that swap dealers using it would be speaking the same language. For instance,
parties could incorporate representations and warranties from the SWAPS Code wholesale by stipulating that they were
incorporating them “as defined in the SWAPS Code” rather than negotiating and drafting them. The SWAPS Code was thus a
great leap forward in standardization of the swaps market.
2. ISDA
The initial membership of ISDA consisted of the eleven participants in the development of the SWAPS Code. The board
comprised ten representatives from those institutions with the board chairman *239 functioning as the chief executive officer
of the organization.139 By the time it held its first formal meeting in August 1985, ISDA’s membership had grown to
twenty-seven. ISDA’s board first hired an Executive Director and, eventually, a small staff to handle ISDA’s administrative
duties and to assist the board in implementing its policies and decisions. During this period of formation, the board controlled
even technical decisions and day-to-day management, such as the hiring, firing, and compensation of employees and the use
and selection of consultants.140
Membership in the organization was limited to institutions that acted as dealers in the swaps market. 141 Entities that
participated in the swaps markets solely for risk hedging or asset/liability management (i.e., end-users) were not eligible for
membership. Members paid dues and were assessed extra fees as the association’s activities required. 142
The by-laws delineate the process for board selection. Directors are selected each year through a vote of the membership at
the annual meeting.143 Each director serves a two-year term, with terms staggered so that approximately half of the board is
up for re-election each year.144 Nominations are made by the nominating committee, which consists of all of the directors
who are not up for election in *240 that year. Although there are no formal criteria for the selection of directors, the primary
goals of the nominating committee have been to nominate individuals from institutions that are representative of the
membership as a whole in terms of the nationalities and the volumes of transactions in the industry (i.e., institutions that
engage in a large number of high-value transactions are more heavily represented on the board than smaller institutions that
are only peripheral industry players).145 Although there are by-law provisions that allow the membership at large to nominate
their own board nominees for the election, in practice they have never been used. The nominating committee has nominated
all directors, presenting a slate that has always been elected at the annual meetings. 146
ISDA outsourced its legal work from the beginning. Outside counsel attended all board and committee meetings and advised
on documentation and, eventually, on regulatory issues. Cravath remained outside counsel, and its lawyers became heavily
involved in the organization. Dan Cunningham, a partner at Cravath’s New York office since 1983 and a pioneer of swaps,
has been involved in ISDA from the start. Jeffrey Golden, originally at Cravath and now a partner at Allen & Overy in
London, was involved with ISDA since its first informal meetings. Allen & Overy functions as ISDA’s primary European
counsel. Robert Pickel, a former Cravath associate, was hired as in-house General Counsel for ISDA in 1997 and is now
Executive Director. Rick Grove, ISDA’s Executive Director from 1997 to January 2001, had also been at Cravath.147
D. Development: Late 1980s to Mid-1990s
1. Growth
For ISDA, the late 1980s and early 1990s were characterized by rapid growth in the swaps and derivatives market, steady
growth in ISDA’s membership, and a dramatic expansion of the scope of ISDA’s activities.
*241 During this time period, the OTC derivatives industry grew at astounding rates. In 1987, the total of all outstanding
notional amounts used in the swap industry was estimated at approximately $900 billion.148 By 1990, that figure had grown
to almost $3.5 trillion.149 By the end of the 1990s, the industry, which had expanded exponentially to include an incredible
array of OTC derivative products that saw widespread use by many types of end-users, was estimated to encompass
outstanding notional amounts of close to $60 trillion.150
ISDA itself has grown steadily from the time of its creation through the present. Motivated both by interest in its activities
from other market players and a desire to increase the revenue base of the organization, ISDA developed three membership
categories. The first, Primary Membership, was open to the same types of entities that had initially been eligible for ISDA
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membership, dealers in swaps and other OTC derivatives. 151 Only Primary Members have the right to be represented on the
board of directors and to vote in board elections. Associate Membership, the first new membership category to be added, was
designed for professional service firms, such as law firms, accounting firms, and consulting firms that participated in the
OTC swaps and derivatives industry as service providers.152 In 1988, ISDA added the Subscriber membership category,
targeted at end-users of swaps, such as corporations and governments. 153
By the end of the 1980s, the membership had grown to approximately eighty Primary Members, about 20 Associate
Members, and about half a dozen Subscribers drawn from all parts of the world. 154 At the beginning of 2001, there are over
200 Primary Members155 and well over 100 each of Associate Members156 and Subscribers.157 *242 In response to the
increasing diversity of its membership, both geographically and in terms of the types of instruments traded, ISDA steadily
increased the number of directors during the eighties and nineties so that the by-law-authorized maximum board size reached
eighteen by the late 1980s and twenty-five by the end of the 1990s. This enlargement allowed most constituencies within
ISDA to have a voice on the board.158
Although the board expanded, ISDA’s staff remained small throughout the late 1980s and early 1990s. The Executive
Director performed staff functions; he attended board and committee meetings and worked directly with the board to
facilitate and execute board decisions.159 The board continued to control the day-to-day operation of ISDA.
2. Committees
During this period of growth, committees proliferated at ISDA. Industry needs dictated committee formation. If a new
product160 or market161 was gaining in importance, a committee would be formed to address it. 162 Often this would occur
when a “critical mass” of members pressed for a committee.163 The committee would then serve as a forum for members to
gather and share views on the subject and coordinate action with regard to it. 164
The composition and functioning of ISDA’s committees vary widely. 165 Models range from relatively small committees with
a fixed membership, such as the U.S. Regulatory Committee, to enormous committees with numerous subcommittees, such
as the Documentation Committee. Certain committees have a core group that meets regularly. Other committees meet more
sporadically, as their work requires, and have a broad membership with varying levels of participation. Membership in these
committees puts an individual at the member institution on the committee’s distribution and email list. This will keep the
member apprised of developments within the committee. Participation beyond this passive information-receiving level is
voluntary, and often only a small proportion of the committee *243 membership will attend all meetings and take an active
role in its work. In other cases, attendance is enormous. For instance, five task forces were formed in relation to the
changeover to the Euro. Each of these five task forces had attendance at its meetings of between 75 and 100. 166
This structure allows ISDA members to stay updated on developments in many committees without requiring them to
commit the time and personnel to actively participate in each of them. The wide range of committee shapes and sizes also
allows groups to structure themselves in the most efficient form for their task. In some cases, such as the strategic
documentation review in the late 1990s, subcommittee sizes were strictly limited, so that small, efficient groups could work
quickly and report back to a larger committee open to all members. 167
3. The ISDA Master Agreement
In the year following its formal creation, ISDA remained focused on standardizing terms and vocabulary, and it released an
update of the SWAPS Code in 1986. In 1987, ISDA also published interest-rate and currency definitions.168 Like the original
SWAPS Code, the development of these definitions was primarily done by ISDA members based in New York. During this
period, some ISDA members in London, particularly Morgan Stanley’s London office, began to push for the creation of a
full, standardized master agreement.
Unlike the New York membership, which remained reluctant to attempt to develop a standard form contract for the industry,
the London members saw a standardized master agreement as the logical next step. 169 ISDA’s board of directors agreed, and
the London membership and counsel took the lead role in the new documentation project. 170 The end result was a pair of
standard form master agreements, one for U.S.-dollar interest-rate swaps, and another for multicurrency interest-rate and
currency swaps.171 Collectively, these *244 two standard master agreements are referred to as the 1987 ISDA Master
Agreement.172
The London group adopted the highly successful drafting process developed during the creation of the original SWAPS
Code.173 What had once seemed an insurmountable task was made manageable by the working relationships and trust that
had been built between the participants over the course of developing the SWAPS Code and subsequent definitions. In
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addition, most of the building blocks for a master agreement had already been created and agreed upon in the SWAPS Code.
A large part of the task was merely rearranging those blocks from menu form into contract form. 174
There were some serious challenges, however. The swaps market was unusual in the 1980s, in that both commercial banks
and investment banks participated as dealers. When trying to nail down contract terms, a culture clash between the two types
of organizations became apparent. Commercial banks, which are used to long-term lending relationships, wanted stringent
credit and default terms, such as cross-default provisions.175 These provisions are crucial to commercial banks, since they
allow the bank to act quickly on deteriorating counterparty credit as soon as the bank detects it, by declaring a default on all
obligations and forcing the counterparty to negotiate a work-out or similar plan for payment. The investment banks, which
were used to much shorter credit exposures, did not believe they needed these provisions in their agreements, and definitely
did not want cross-default provisions to be automatically included in their contracts with other major swap dealers, such as
commercial banks.176 The eventual solution was to make cross-default an elective contract term.
This resolution illustrates the three-tiered approach to standardization adopted by ISDA’s drafters in their attempts to codify
consensus to the degree it existed in the market. First, if a single consensus *245 existed, or could be reached through
discussion and negotiation between market participants, the drafters would capture the consensus and make it a standard
definition or contract term. Second, if a consensus did not exist but a majority view did, drafters would codify that majority
view and make it a presumption out of which the parties were free to opt. Finally, if there was a spectrum of views in the
market, each of those views was codified, and the set of options was presented as a menu from which contracting parties
could choose.177
Major documentation accomplishments of ISDA during the early nineties included the re-drafting of the 1987 ISDA Master
Agreement (resulting in the 1992 ISDA Master Agreement), 178 the development of the 1991 ISDA Definitions,179 the
development of credit support and collateral documentation, and the development of definition booklets tailored to specific
types of transactions. Some of these documents are detailed in Standard Form Documentation, above.
4. An Expansion of Scope
Starting in the late 1980s, the scope of ISDA’s activities began to expand beyond just documentation. ISDA became involved
in discussions with regulators on behalf of the OTC derivatives industry. 180 ISDA board members and representatives now
regularly testify *246 before congressional committees.181 ISDA has played a key role in keeping the OTC derivatives
industry self-regulated. It has coordinated industry opposition to CFTC and SEC regulation, acting both as an advocate for
the industry and as an instrument for its self-regulation. ISDA has also lobbied successfully to get legislation passed in the
U.S. explicitly recognizing the validity of netting agreements for derivatives contracts in bankruptcy contexts. 182
ISDA also continued to expand its commitment to non-documentation activities.183 Over the course of the 1990s, dealing
with regulatory matters, accounting issues, and the development of legal certainty for derivatives 184 became substantial areas
of activity for ISDA.185
*247 In addition, ISDA has conducted annual market surveys of the OTC derivatives industry since soon after its formation.
The initial surveys were conducted by Touche Ross at no cost to ISDA, then later by Arthur Andersen under commercial
contract.186
E. Transformation: Mid-1990s to 2001
1. Changing the Model
The rapid growth in membership and the expansion of the scope of ISDA’s activities in the late 1980s and early 1990s was
followed by a fundamental shift in the way in which ISDA was run as an organization. 187 From the time of ISDA’s
formation, the day-to-day management of the organization had been controlled by the board of directors. 188 Within the board,
a core group of eight to ten directors handled much of the general management decisions. 189 The organization was lightly
staffed, with the Executive Director performing most administrative, facilitation and logistical duties. Legal expertise was
outsourced, initially to Cravath in New York, and by the mid-1990s, to Allen & Overy in London as well.190
As the organization and the scope of its activities grew, the time demands placed on the directors became extreme, even with
increases in the size of the board.191 Some directors were spending several hours of each day on the active management of
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ISDA, while also retaining their responsibilities at their own institutions 192 The control model that had been an integral part
of ISDA’s first decade of existence was no longer a good fit.
In 1993, a majority of the board agreed to begin transforming the organization into a more “traditional,” staff-driven trade
association.193 The board expanded the size and capabilities of the staff. 194 *248 Since 1993, ISDA’s staff has more than
tripled, now with twenty-three employees in New York, nine in London, four in Tokyo, and two in Singapore. 195 These
employees have taken over many of the functions previously performed by the board. 196 The professional capabilities of the
staff expanded dramatically with the hiring of a General Counsel in 1996, as well as additional legal staff, accountants,
industry experts and public relations professionals.197 ISDA employees currently play a much more active role in policy
development than they had in the early to mid-1990s. Full-time staff members appear in Washington, D.C., on behalf of the
organization, and monitor and respond to developments in international regulation. The General Counsel now oversees most
documentation efforts.198
The role of the Executive Director also shifted over this period. Bradley Ziff, who held the position from 1988 to 1993, notes
that he was often the only staff representative at committee meetings. 199 He had very few employees to manage, and all
professional services were outsourced.200 By contrast, as Executive Director from 1997 to January 2001, Rick Grove was
CEO of ISDA. He controlled the hiring, firing, and compensation of staff, controlled and directed ISDA’s spending, and was
responsible for day-to-day management.201 He also held a seat on the board.202
In 1996, the board took a further step toward relinquishing day-to-day control of ISDA’s operations by reducing its meeting
schedule from monthly to five or six meetings per year. To maintain the board’s ability to respond quickly and handle
time-sensitive issues, the board established an Executive Committee consisting of the officers on the board and a rotating
group of two or three other board members. It meets every three to four weeks, and has the authority to make many of the
decisions otherwise reserved for the board as a whole. 203 The full board now deals primarily with larger policy issues, such
as the creation of new committees and approval of the budget. 204
*249 With the shift in the role of the board, committees have become even more crucial at ISDA. Rick Grove notes that
ISDA is a “very member-driven” organization, and that “member input comes through the committee structure.”205 The large
number of committees allows for a very broad base of participation by the membership. Grove estimates that thousands of
lawyers, risk managers, and market professionals participate in ISDA projects through the committees. 206
In the mid-1990s, ISDA began formally internationalizing the organization’s staff by opening an office in London. 207 The
move reflected the strong European presence in the organization. At that time, even the chairman of the board, Gay Evans,
was based in the U.K.208 From the time of its creation, the London office began to participate in documentation projects
(taking the lead role in some) and to coordinate European input into the organization. 209 The board’s composition also
reflects the international membership, now including representatives from institutions based on four continents. 210
2. Current Drafting Processes
Although ISDA’s General Counsel now actively oversees and participates in all of ISDA’s documentation efforts, ISDA
continues to outsource most of its legal work.211 ISDA’s primary U.S. counsel remains Cravath in New York, and its primary
counsel in Europe is Allen & Overy in London. 212 Generally, one of the two firms will take the lead role in each of ISDA’s
documentation projects.213
Committee meetings usually take place either at the offices of outside counsel or at a member’s office. For major
documentation projects, there may be simultaneous meetings in two or more cities. 214 Lawyers from the lead firm will attend
the meetings, but *250 ISDA’s General Counsel usually presides.215 This is a recent change from ISDA’s past practice of
having outside counsel run documentation meetings.
Detailed drafting work is often done by a sub-committee, called a “core working group,” which reports back to a
documentation task force or working group, which in turn will report to the relevant committee in charge of a particular
market area, such as credit derivatives or collateral.216 As in ISDA’s early days, the committee participants themselves are
often in-house lawyers from ISDA member institutions.217 Participants are encouraged to voice opinions and talk all issues
through to a compromise.218 Some committee members have complained during meetings that the process of airing every
participant’s concerns can be “tedious,” but participants generally agree that more input leads both to better results in terms
of the substantive work product and to broader acceptance by the organization and the industry.219
In cases in which the committee cannot establish a consensus, the issue may be referred, via ISDA’s General Counsel, to
another committee (for instance, to the Trading Practice Committee, which consists primarily of traders), to establish what
the market standard is that should be reflected in the documentation.220 Rick Grove notes that when policy disagreements
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arise, there is an assumption that the issue will be talked out, and a consensus reached, rather than resorting to a majority-rule
vote. In some cases, members may discuss the issues off-line to help resolve them.221 Bob Pickel says one of the reasons that
votes are avoided at the committee level, beyond a commitment to building consensus, is that membership on most
committees is fairly informal, so that many committee members may not be present at a given meeting, and some institutions
may be represented by several people. If a vote is required to resolve an issue, the vote will take place at the board level. 222
Following each meeting, the outside counsel will attempt to capture the consensus developed in the meeting with a draft
document. *251 After the initial drafting, the lawyers circulate the draft among the committee members participating in the
core working group.223 After redrafting and approval, the draft is circulated at the next level of the committee. 224 Ultimately,
all drafts are submitted to the full Documentation Committee for review.225 Final approval for their adoption and release is
still reserved for the board.226
3. A New Type of Challenge: Master Masters
As ISDA and the OTC derivatives industry grow in importance, ISDA’s actions will increasingly begin to have an effect on
financial markets beyond the OTC derivatives market. This role will present fresh challenges to ISDA as it deals with new
industries. One ongoing example is the debate over master master agreements.
Various master agreements (in addition to ISDA’s) are now used for a number of different types of financial instruments,
including non-derivative financial transactions. In an effort to further manage risk and net exposures against counterparties,
there has been a movement to consolidate as many different types of products, transactions, and payments as possible under a
single master agreement.227 Industry players and legal advisors tend to agree that this consolidation is a good idea. There are
generally two competing models, however, for how this goal should be accomplished.228 The first is to create a master
agreement that is flexible enough to encompass a wide range of financial transactions. This is the path that the ISDA Master
Agreement took in 1992, when it was redesigned so as to accommodate the variety of derivative instruments that had
developed since the drafting of the 1987 ISDA Master Agreement. Because OTC derivatives have so many variations, the
ISDA Master Agreement had to be much more flexible than comparable master agreements for other financial products. As a
result, it is the closest thing currently in use to a master agreement capable of handling all types of financial transactions.229
*252 The second model is to create a ‘master master‘ - an overarching master agreement to bind a number of separate master
agreements together. A master master lies on top of the other masters, joining them in the same manner that a normal master
agreement binds together individual transactions.230 The use of a master master has the benefit of allowing parties to net
different types of obligations against each other, without altering the current system of multiple master agreements that each
cover a different type of financial transaction. It requires no great change in industry practice or documentation methods. A
standardized master master, called the Cross-Product Master Agreement (CPMA), drafted by Clifford Chance’s New York
office, was recently released by The Bond Market Association (TBMA), a primarily U.S. trade association. 231
There are some concerns about the use of master masters. The modifications a master master makes to the other masters that
it binds together (including the ISDA Master Agreement), may be found in some jurisdictions to be legally ineffective to
unify the underlying master agreements, or even to destroy all close-out netting for the parties, leaving the non-bankrupt
party much worse off than it would have been without the master master. There is also a risk that, in jurisdictions that have
adopted legislation specifically permitting close-out netting of the sort in the 1992 ISDA Master Agreement, a master master
would not fit within the scope of the legislation.232
In addition, TBMA has only commissioned legal opinions regarding the CPMA for the U.S. and England so far. 233 The lack
of legal opinions to date supporting the enforceability of the CPMA’s netting provisions in other jurisdictions limits its
usefulness in international settings, where parties may have to comply with BIS guidelines that require such opinions for
financial institutions to net their obligations against counterparties. 234 By contrast, the ISDA Master is supported by
constantly updated opinions for over 30 jurisdictions. 235
The debate over master master agreements presents ISDA with a new sort of challenge. As the importance of OTC
derivatives in the financial markets grows, ISDA will find itself increasingly interacting with other trade associations, such as
TBMA. Many of these trade *253 associations will have a membership that overlaps substantially with ISDA’s. They may
also promulgate standard documentation that overlaps, or even directly conflicts, with ISDA’s.
Much of ISDA’s future, and the future of ISDA’s standard form documents will hinge on how ISDA manages these
relationships and how it negotiates the delineation or overlap of its spheres of influence in relation to other trade associations.
Already, ISDA has entered into joint projects with other organizations, such as the New York Foreign Exchange Committee
and the British Bankers’ Association. Rick Grove notes that there is a great demand for such projects from ISDA’s
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membership.236 ISDA’s primary challenges have shifted over its life from managing relationships between its members in
the 1980s to managing relationships between its directors and staff in the 1990s to managing relationships with other
organizations in the new millennium.
IV. Lessons from ISDA
ISDA has traveled an amazing course. In the space of fifteen years, it has guided and held together an industry that has grown
and changed by the month. It has turned competitors into collaborators and created documents that have remained the
accepted standard through seventy-fold industry growth and constant product innovations. In the face of high profile
bankruptcies and losses associated with derivatives, ISDA has maintained constructive relations with regulators around the
world. It is entering the new millennium with an important role to play in the future of global financial markets.
Clearly, ISDA has been doing something right. This section attempts to identify some specific factors that have contributed to
its success. While not all of these factors are replicable, they are certainly instructive, and some may be of help to similar
associations, joint ventures, nonprofit organizations, businesses, lawyers, and negotiators.
Factors that have contributed to ISDA’s success as an organization can be roughly divided into three categories: its ability to
manage external relationships (with members, the industry, regulators, etc.); its ability to manage its internal relationships
(between board and staff, board and committees, and with its directors and legal *254 counsel); and its ability to manage the
process of cooperative negotiation and drafting of industry standards. An analysis of ISDA’s success in these three areas
follows.
A. Industry Relations
There are three primary reasons for ISDA’s success within the industry as a whole. First, its founding members were able to
convince key industry players to negotiate multiple industry standards simultaneously. Second, once ISDA was in existence,
it created value for its members that would be lost if the organization failed. Finally, ISDA took advantage of opportunities to
build on its successes.
1. A Concentration of Negotiations
The group that eventually became ISDA had as an initial purpose the development of some sort of standard form
documentation for the OTC derivatives industry. While this sounds simple enough, it was actually a risky strategy for the
participants. A project such as this concentrates thousands of negotiations into one. Absent standardization, each industry
participant would negotiate every term of every contract with other participants individually. The participants could learn
from their mistakes, experiment, and offer different terms to different counterparties. However, by agreeing on a standard,
each party limits its ability to do these things.
In addition, if the standard ultimately reached is unfavorable to a party, that party will either be forced to negotiate variances
from the standard form on each of its contracts, or be stuck with terms that are worse than those it had previously used. As a
result, the stakes involved in standardization projects such as ISDA’s are higher than they may appear at first. The parties
proposing standardization may be faced with a difficult task in trying to enlist the cooperation of the other industry
participants. Even once that cooperation is gained, the other parties may be wary. This appears to have been the case for
ISDA, where the first standardization attempt failed when some parties feared their interests were not being met.
The key for proponents of standardization is to convince the other parties that they will be better off with a standardized
document. While it may seem counterintuitive that a standardized document could be inherently better for a given party than
an individually tailored document, this is not necessarily so. Arguably, a better contract (which is more beneficial to both
parties, on average) can be developed through a properly facilitated, thorough, and cooperative group process, than through
an adversarial two-party negotiation. If *255 this is the case, participants are faced with a choice between negotiating
extremely thoroughly on one occasion, and sharing the cost, or else negotiating repeatedly--and sometimes poorly--and
shouldering the entire cost.
Put in these terms, the concentration of thousands of negotiations into one can be seen as an opportunity rather than a danger.
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In ISDA’s case, the result certainly seems to have been a success for all involved.
2. Stakes
One factor that helped keep ISDA’s membership committed to the organization and its documentation projects was what the
members faced if ISDA were to fall apart. ISDA’s initial documentation successes proved that industry participants could get
good documentation results through ISDA at a fraction of their previous costs. In addition to reducing costs, ISDA’s
standardized documents reduced risk for everyone in the industry. If a standardized netting provision of the ISDA Master
Agreement were challenged in court, every industry participant would learn from the result because all were using identical
provisions and ISDA would coordinate any necessary adjustments to the documentation. An end to ISDA meant an end to
this standardization and its dual benefits. These factors provided strong incentive for ISDA’s membership to keep ISDA
strong, despite rapid growth and shifts in its control structures, and gave members incentive to work through disagreements.
3. Taking Advantage of Success
A third factor that has helped to place ISDA where it is today is the willingness of its membership to build on its successes.
For example, at the time of ISDA’s formation, industry participants believed that it would be impossible to reach an
agreement on a fully standardized contract form. Within two years, however, building on the success of the SWAPS Code
and its 1986 update, ISDA had managed to create a contract that was quickly adopted by the industry. 237
Similarly, ISDA has been reluctant to rest on its laurels. Successful documentation projects are subject to constant review and
update in order to keep them current with developments in the industry.238 ISDA also used its early successes in the realm of
documentation to take a lead in regulatory matters and the establishment *256 of legal certainty.239 Just as the OTC
derivatives industry has changed dramatically over the last fifteen years, ISDA has refused to be bound by its past limitations
or confined to its current roles.
B. Organizational Control
Three internal factors contributed greatly to ISDA’s success as an organization. First, it had an appropriate mix of formality
and flexibility. Second, the organization was able to adjust its control structures to meet the demands placed on it by growth.
Finally, the continuity of involvement from certain key players has preserved ISDA’s institutional memory and allowed it to
maintain and develop expertise.
1. Formality and Flexibility
Although it has become increasingly formalized, ISDA has managed to retain a large degree of flexibility; this flexibility
allows rapid growth and adaptation that would not be possible in a more rigid organization. From the time of its formation,
ISDA has placed more importance on its concrete goals and tasks than on the formal structure of the organization. The group
that had formed in 1984 did not even consider incorporating as a formal nonprofit organization until it realized that an entity
was needed to hold the copyright for the SWAPS Code.240
Incorporation did not change ISDA’s flexibility. Committee structures have been kept very loose, allowing for committees of
all shapes and sizes to be created. This permits the organization to design the most appropriate group-- sometimes small and
focused, sometimes large with a broad scope--to address each task. The organization’s willingness to disband committees that
have completed their purposes (although committees are generally created at a much faster rate than they are dissolved) also
reflects this flexibility and general lack of institutional inertia. 241
Finally, ISDA has shown a willingness to let groups within the organization “take the ball and run with it.” For instance,
when members in London expressed an interest in developing a standardized master agreement, they were given the lead role
on the project.242 Similarly, if a group of members that has an interest in a certain *257 aspect of the industry develops, a
committee will be created for those members, giving the group legitimacy within the organization and access to ISDA
resources.243 This commitment to remaining flexible, and a willingness to grant formal legitimacy to informally organized
groups, have allowed ISDA to adapt quickly to a rapidly changing industry.
2. Shifting Gears
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In the mid-1990s, ISDA made substantial changes in its control structures. The board moved from a role in which it actively
controlled almost all aspects of ISDA’s operations, to a more policy-oriented role with a reduced schedule of meetings. The
size, skill set, and range of duties of the staff were increased and the board delegated more responsibilities to committees.244
The size and range of activities of the organization had grown beyond that which a small group of individuals could
effectively run on a part-time basis. It was a major accomplishment for the board itself to recognize the need for this shift. By
acknowledging its own limitations and ceding some control to a full-time staff and a broad base of committees, the board was
able to ensure that ISDA could continue to grow in size and scope.
Other groups may be able to utilize a similar structural change in the control of an organization in cases where the
effectiveness of the board is impaired. For instance, when a board of directors or other central governing body has become
ineffective because of work overload, deadlock, high turnover, personality conflicts, unwieldy size, or other factors, the
obstacle can be bypassed with a structural change in the control of the organization. By increasing staff control, broadening
the control base to include committees run by the general membership, or cutting the ability of the board to micromanage the
organization by reducing its meeting schedule, an organization can shift gears into a more appropriate control structure for its
size and objectives.
3. Institutional Memory
Finally, ISDA’s ability to keep key members involved over a long period has helped create a strong institutional memory
within the *258 organization.245 Although difficult to illustrate with concrete examples, the importance of institutional
memory cannot be overemphasized, particularly in a constantly changing membership-based organization such as ISDA.
Such a memory is crucial to success. It prevents mistakes from being repeated, allows the organization to retain skills and
knowledge to pass on to new members, and contributes to the organization’s ability to focus on developing new capabilities
rather than relearning old ones.
Institutional memory has been an important factor in the continued success of ISDA’s drafting procedures. Because many
current participants, including Grove, Pickel, Cunningham, and Golden, have been involved with ISDA since the 1980s and
early 1990s, ISDA has never had to reinvent the wheel. Instead, these skills have been constantly developed and refined with
each new project.246
ISDA has had similar success in keeping individuals at the board level involved for long periods. Joseph Bauman, for
instance, was a director for ten years. While most directors only serve for two to four years, those who stay on for longer
periods have ensured that the board has a similar degree of institutional memory to that of the staff and outside counsel. 247
C. Drafting Committees
Some of ISDA’s greatest and most easily replicable successes have come at the drafting committee level. ISDA’s ability to
set achievable goals, involve the right players, and frame the decision-making process appropriately has been instrumental in
its development of well-accepted standard form documentation. After a discussion of these three points, this section
concludes with a group of lessons regarding the drafting process drawn from one lawyer’s experience with ISDA.
1. Goals
From the start, ISDA has set reasonable goals for itself. When a full contract appeared to be out of reach, it settled on the
development of a set of definitions and standard contract terms.248 Only by setting this achievable initial goal was ISDA then
able to release a fully standardized contract two years later.
*259 Similarly, reasonable and achievable goals guide ISDA’s documentation committees. Rather than attempting to force a
consensus, or expecting a decision reached by majority vote to justify the imposition of a standard on the industry,
documentation committees seek only to codify consensus to the extent it actually exists. The three-tiered approach to
standardization in which a true consensus, a prevalent view, or a spectrum of views can each be codified in ways that reflect
the level of acceptance within the industry allows the committee to achieve standardization without ignoring diversity of
opinion. These realistic drafting goals give comfort to the membership. Members will not be concerned that they will be
forced in the name of consensus or by majority vote to endorse a standard that ignores their interests.
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2. Players
Another key to the success of ISDA’s drafting procedures, which leads to both technically strong documentation and wide
acceptance in the marketplace, is the inclusion of a broad range of players. Bankers, traders, in-house counsel and outside
counsel all participate in drafting projects, both in core working groups and in the review of drafts. 249 This broad input and
feedback ensures that documents are legally sound, understandable, and appropriate for use in the market. The large number
of people who draft and review each document also helps identify any considerations that may have been missed by smaller
or single-discipline drafting groups.
3. Framing
ISDA’s experience with the drafting of the SWAPS Code highlights a valuable lesson, which is particularly applicable in the
context of negotiations. The initial attempt to draft a single contract failed because participants in the process had difficulty
looking past the typeface and format of the document that was being produced. Concerns over form were overshadowing
concerns over substance.250
In abandoning the “contract” format, ISDA’s outside counsel eliminated any chance that the new process would produce a
document that could be mistaken for one party’s standard form. Individual terms were separated from each other, each
isolated on a different page. Once the parties were no longer able to associate the *260 document with any individual
participant in the negotiations, emotional attachment to, or dislike for, certain contract forms was left behind. The negotiators
were able to focus strictly on substance, and move forward where the previous attempt had failed. 251
Thus, the manner in which the parties to the negotiation were presented with the subject matter of the negotiation had an
important effect on how the negotiation itself proceeded. By separating the substance of the contract from its form, the
negotiation was reframed from one about whose standard form contract was going to “win,” into a negotiation about what
each term of an ideal contract would look like.
4. Drafting Documents that Last
When asked what lessons one could draw from ISDA’s experience, Jeffrey Golden identifies five principles of drafting that
have guided ISDA’s documentation projects. These principles are summarized below.
a. Never Compromise on Quality
As straightforward as this proposition sounds, it is, to a certain degree, in tension with ISDA’s practice of capturing market
consensus in its standardized documents. When a practice is generally accepted in the market, or when there is a compromise
to which all members of the drafting committee are willing to agree, it is easy to capture the consensus, declare victory over
the problem, and move on. However, this may not always result in the best solution for the users of the contract.
Never compromising on quality means that drafters attempt not just to capture market consensus, but also to test that
consensus objectively to see if it is the most beneficial solution for the participants. Says Golden, “you don’t just ‘get to yes.’
You need to make sure, through due diligence, that the consensus is correct.”252
For instance, when ISDA set out to draft the 1987 ISDA Master Agreement, the market consensus was that a single contract
could not be used for both English and U.S. law. When the lawyers involved in the drafting process actually investigated the
possibility, however, they discovered that the differences in U.S. and English contract forms currently in use in the market
were remnants of custom and legal culture, and were not actually legally relevant. By testing the *261 validity of the market
consensus, the drafting committee was able to produce a single master agreement, the users of which could choose to be
governed by U.S. or English law simply by checking a box. 253
b. Process is Key
Process, as has been discussed in previous sections, has been one of the keys to the success of ISDA’s standardization efforts.
The drafting processes that have been developed by ISDA emphasize openness, broadness of participation, multidisciplinary
input, and consensus-building.254
In addition, however, ISDA’s process extends to include repeatedly revisiting completed documentation to ensure that it
remains appropriate for the market and that no weaknesses have appeared in the course of its use. This process of
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maintenance has been central to ISDA’s documentation efforts from the start. ISDA re-drafted the SWAPS Code in 1986, a
year after its initial release. The 1987 ISDA Master Agreement was re-drafted in 1992. The definitions released in 1987,
alongside the agreement, were revised in 1991 and again in 1998 and 2000. Amendments and additional standardized
provisions for the 1992 ISDA Master Agreement are continually released. 255 Golden captures this practice with a metaphor.
“You are not just building a bridge and leaving it. You have to maintain and paint the bridge and, by the time you finish
painting the far end, it is usually time to start re-painting the near end.‘256 For ISDA, creating documentation is like writing
software: it will require updates, it will have bugs that need patches, and it will need revision when new technology demands
it.257
c. Remember the Big Picture
Remembering the big picture first requires looking at the global context in which a document will be used. If parties in
Singapore and New York will be using the document to contract with one another, some standard practices that have
developed in local markets may not be appropriate. For instance, when parties are on opposite sides *262 of the world,
putting a letter in the mail may not be an adequate form of notice. 258
Second, remembering the big picture includes realizing that contracts are not the only way to achieve what is desired. If
certain key contract provisions are not enforceable in a jurisdiction, the “little picture” solution is to draft alternate provisions
that approximate the desired result. The “big picture” solution may be to change the legislation in that jurisdiction. Golden
notes that many laws dealing with financial matters have aged poorly, given the developments in markets over the last two
decades. Old laws relevant to netting or withholding may not serve their intended purposes when they are applied to modern
financial instruments. In some cases, ISDA has been successful in obtaining replacement legislation, such as U.S. legislation
explicitly recognizing close-out netting, that accomplishes more for the industry than the best contract drafting can. 259
d. Get Down to Fundamentals
This principle involves breaking the documents being drafted into their building blocks. This was an extremely effective tool
in the negotiations over the SWAPS Code.260 By focusing on individual components, the drafters will better understand how
the whole document fits together, the importance of each piece, and what parts of the document may be altered without
affecting the others.
e. Education
Finally, Golden highlights education as a key aspect of drafting effective documents, particularly for ISDA. He identifies two
distinct types of education that are crucial. First--and most obvious--is the education of users of the documentation. Users
who understand how and why their contracts work and what may safely be altered in the document will be able to take
advantage of the documentation to its fullest extent.
More important than this type of education, however, is the education of regulators. By constantly interacting with regulators
in its home jurisdictions and in emerging markets, ISDA helps to ensure the success of its industry and continued industry
self-regulation. *263 Regulators who are able to understand the nature of the documentation and the transactions taking place
in the industry will be more open to discussions with the industry and the organization. New markets are opened up for the
OTC Derivative industry each year by ISDA, as countries tailor their laws to accommodate key provisions of ISDA
documents. ISDA is currently meeting with, among other countries, Israel, Greece, Turkey, Hungary, Poland and
Slovakia.261 Without education, emerging markets will remain closed to derivatives.
V. Conclusion
ISDA’s experience is in many ways unique. The explosion of the OTC derivatives market is rarely mirrored in other
industries. Few industries, even in other financial markets, require the detail and volume of documentation demanded by
derivatives. It may also be rare to find a membership that will participate so enthusiastically in the activities of an
organization.
These particular characteristics do not mean, however, that ISDA’s experiences and innovations are inapplicable to other
situations. Any organization can benefit by capitalizing on successes or making its members aware of the drawbacks of
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losing the organization’s services. Any situation in which parties must repeatedly negotiate with one another may also be
potentially improved with the setting of standards through a thorough and collaborative one-time negotiation process.
While preserving flexibility and institutional memory are not particularly profound recommendations, ISDA’s experiences
with them may help illustrate for other groups how a formal organization can remain flexible, and how institutional memory
can be retained in a membership-based setting. The changes in ISDA’s control structures provide a model for how an
organization that had initially been controlled by a small group, but has grown too large for them to manage, can make the
transition to a more mature structure without tearing itself apart in the process.
Finally, ISDA’s experiences with coordinating the multiparty negotiations that infuse group-drafting processes provide a
detailed view of successful group interaction. By setting achievable goals, choosing the right participants, framing problems
in an appropriate way, and following good drafting principles, ISDA’s documentation committees have been highly effective.
They, and the lawyers who *264 have facilitated their meetings, have developed a successful and easily replicable model for
group drafting processes.
If ISDA remains flexible, continues to adjust its control structures to match the requirements of its activities, and further
hones its group-process capabilities to accommodate its large membership, it will play an important role in the financial
markets of the coming decades.
Footnotes
d1
Associate, Allen & Overy. Harvard Law School, J.D., 2000. The research and writing of this paper was funded by a Hewlett
Fellowship, provided by the Harvard Negotition Research Project at Harvard Law School. I would like to thank Bob Mnookin,
Bob Bordone, the Hewlett Foundation, Harvard Negotiation Research Project, Jeff Gelden, and Carolyn Jackson for their
invaluable help in the research and development of this paper.
1
With the exception of the next section that describes how derivatives themselves work, the material presented in this paper is
largely the result of a series of interviews conducted with past and present directors, staff, and outside counsel of ISDA.
2
One scholar defines a derivative as “a contract that either allows or obligates one of the parties (the “end-user”) to buy or sell an
asset.” Henry T.C. Hu, Misunderstood Derivatives: The Causes of Informational Failure and the Promise of Regulatory
Incrementalism, 102 Yale L.J. 1457, 1464 (1993) (reviewing Peter L. Bernstein, Capital Ideas: The Improbable Origins of
Modern Wall Street (1992)).
3
See Robert M. McLaughlin, Over-the-Counter Derivatives Products: A Guide To Business and Legal Risk Management and
Documentation xviii (1999); Carolyn H. Jackson, Note, Have you Hedged Today? The Inevitable Advent of Consumer
Derivatives, 67 Fordham L. Rev. 3205, 3256 (1999).
4
See infra Part II.C.1.
5
See infra Part II.C.2.
6
See Lillian Chew, Managing Derivative Risks: The Use and Abuse of Leverage 5 (1996); Roberta Romano, A Thumbnail Sketch
of Derivative Securities and Their Regulation, 55 Md. L. Rev. 1, 10 (1996). For more information on the uses of derivatives, see
generally Joseph L. Motes III, Comment, A Primer on the Trade and Regulation of Derivative Instruments, 49 SMU L. Rev. 579,
585-87 (1996).
7
See Hu, supra note 2, at 1465; Motes, supra note 6, at 584.
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8
See Romano, supra note 6, at 10.
9
Motes, supra note 6, at 584.
10
Telephone Interview with Richard Tredgett, Solicitor, Allen & Overy (March 31, 2000) [hereinafter Tredgett Interview].
11
See Motes, supra note 6, at 588.
12
Of course, there is some opportunity cost. Although the farmer has hedged against a fall in market price, he has forgone the ability
to profit from a rise in market price.
13
Reuters Ltd., An Introduction to Derivatives 13 (1999).
14
See Romano, supra note 6, at 8.
15
See Chew, supra note 6, at 5-6.
16
See Motes, supra note 6, at 586.
17
Chew, supra note 6, at 6.
18
Romano, supra note 6, at 10.
19
See Jackson, supra note 3, at 3213.
20
See Romano, supra note 6, at 10; Hu, supra note 2, at 1465.
21
See Reuters, supra note 13, at 45; Romano, supra note 6, at 16-17.
22
See Romano, supra note 6, at 13.
23
See generally McLaughlin, supra note 3, at 66-73; Telephone Interview with Carolyn Jackson, Executive Director of ISDA,
1995-1997 (February 2, 2000) [hereinafter Jackson Interview].
24
Reuters, supra note 13, at 35, 53.
25
Romano, supra note 6, at 41.
26
Reuters, supra note 13, at 13, 14, 71.
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27
See Motes, supra note 6, at 600.
28
McLaughlin, supra note 3, at 73.
29
Id. at 81-82; Romano, supra note 6, at 40.
30
Jackson Interview, supra note 23.
31
In practice, holders of American options wishing to realize a profit prior to the expiry date will usually enter into an offsetting
contract with the exchange in this manner as well, rather than exercising their option. This allows them to capture the remaining
time value of the option, which is derived from the chance that it will move even further ‘into the money‘ before the expiry date.
McLaughlin, supra note 3, at 81-82.
32
See Motes, supra note 6, at 589.
33
See the discussion of Barings Bank in Part II.C.1, infra, for a lurid example; see also Alfred Steinherr, Derivatives: The Wild
Beast of Finance 97-103 (1998), for a further discussion of the Barings debacle and Reuters, supra note 13, at 105-13, for detailed
graphs showing the payoff characteristics of options.
34
A notional amount is an amount of an underlying asset, such as money or a commodity, which is used to determine payment
amounts and values of derivatives. The notional amount does not generally exist. For instance, two parties can agree to enter into
an interest rate swap (these are discussed later in this section) with a notional amount of $1,000,000. Neither party actually holds
this $1,000,000, nor is the notional amount at risk in the contract, but they will exchange payments as if they were each paying a
different interest rate on an actual amount of $1,000,000. See Romano, supra note 6, at 46-47.
35
Elizabeth Ungar, Swap Literacy: A Comprehensive Guide 10 (1996).
36
Romano, supra note 6, at 65.
37
Ungar, supra note 35, at 11.
38
The farmer will then sell his wheat on the market for $120,000, realizing $100,000 after his payment to the baker. The baker will
purchase wheat for $120,000, but the payment from the farmer will keep his cost to $100,000.
39
Although the farmer is making large net swap payments to the baker, the extra revenue from the rising market price for the wheat
he grows on his farm will offset those payments, such that he will realize $100,000 on his wheat each year.
40
See Ungar, supra note 35, at 19.
41
For examples of actual swap dealers, see Part III.A.
42
See Ungar, supra note 35, at 19; McLaughlin, supra note 3, at 14.
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43
Romano, supra note 6, at 48.
44
See
International
Swaps
and
Derivatives
Association,
Inc.,
All
About
Membership,
at
http://www.isda.org/membership/index.html (last visited January 10, 2001) [hereinafter ISDA Members]; International Swaps and
Derivatives Association, Inc., All About Membership: Primary Membership: List of Primary Members, at
http://www.isda.org/membership/list_of_primary.html. (last visited March 9, 2001) [hereinafter ISDA Primary Membership List].
45
See Romano, supra note 6, at 81-82.
46
See, e.g., Reuters, supra note 13, at 136-37. (no reference to a middleman here, though--exchange is between airline and bank).
47
Id. at 129.
48
Romano, supra note 6, at 47.
49
Ungar, supra note 35, at 138-39.
50
See Romano, supra note 6, at 66-67.
51
See, e.g., Reuters, supra note 13, at 129-30.
52
International Swaps and Derivatives Association, Inc., Market Statistics: Summary of Recent Survey Results: 1997 Year-End
ISDA Market Survey, at http://www.isda.org/statistics/recent.html#1997 (last visited February 15, 2001) [hereinafter ISDA
Market Survey].
53
See Ungar, supra note 35, at 13-14.
54
Id. at 14-15; Romano, supra note 6, at 49.
55
See Ungar, supra note 35, at 15.
56
See McLaughlin, supra note 3, at 14.
57
Telephone Interview with Daniel Cunningham, partner, Cravath, Swaine & Moore (April 18, 2000) [hereinafter Cunningham
Interview].
58
See Ungar, supra note 35, at 92-98, 128-29; Motes, supra note 6, at 597-98.
59
Ungar, supra note 35, at 128.
60
Id.
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61
See id. at 92.
62
In fact, taking market positions is crucial to the derivatives markets. Without participants willing to take risks with derivatives,
dealers would have a hard time finding a hedge for many swaps. For example, a dealer may be faced with ten farmers wanting a
swap to sell wheat, but only five bakers wanting a swap to buy wheat. Without wheat-price position-takers, the dealer would have
to turn away five of the farmers. With position-takers in the market, however, the dealer can enter into ten swaps with farmers,
balance out five of those swaps with baker swaps, and then find five position-takers willing to take the view that wheat prices will
rise (or even one swap with a position-taker, leveraged by a factor of five).
63
McLaughlin, supra note 3, at xvii-xviii.
64
Chew, supra note 6, at 223.
65
Motes, supra note 6, at 611.
66
Chew, supra note 6, at 224.
67
Id. at 223-48.
68
See id.
69
See Motes, supra note 6, at 611.
70
Anatoli Kuprianov, Derivatives Debacles: Case Studies of Large Losses in Derivatives Markets, in Derivatives Handbook: Risk
Management and Control 605, 622-23 (Robert J. Schwartz and Clifford W. Smith, Jr., eds., 1997).
71
See Steinherr, supra note 33, at 100-03; Motes, supra note 6, at 611.
72
See generally Motes, supra note 6, at 608-09; Kuprianov, supra note 70, at 613-14.
73
Wendy H. Brewer, Minimizing Operations Risk, in Derivatives Handbook: Risk Management and Control 39, 46 (Robert J.
Schwartz and Clifford W. Smith, Jr., eds., 1997).
74
Anthony C. Gooch & Linda Klein, A Review of Case Law Affecting Swaps and Related Derivative Instruments: United States
Case Law, in Derivatives Handbook: Risk Management and Control 57, 100 (Robert J. Schwartz and Clifford W. Smith, Jr., eds.,
1997).
75
See note 139, infra.
76
See McLaughlin, supra note 3, at 205-06.
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77
See Gooch & Klein, supra note 74, at 100.
78
Id. at 100-01.
79
Id. at 101; McLaughlin, supra note 3, at 207-08.
80
Following losses by Gibson Greetings under leveraged swaps, U.S. regulators brought an enforcement action against an OTC
derivatives dealer, alleging the existence of an advisory relationship between the dealer and its counterparty that would allow the
counterparty to escape liability for its swap obligations. Gerald D. Gay & Joanne T. Medero, The Economics of Derivatives
Documentation: Private Contracting as a Substitute for Government Regulation, in Derivatives Handbook: Risk Management and
Control 233, 244 (Robert J. Schwartz and Clifford W. Smith, Jr., eds., 1997).
81
Id.
82
See International Swaps and Derivatives Association, Inc., Who We Are, at http://www.isda.org/wwa/index.html (last visited
April 20, 2001) [[hereinafter Who We Are].
83
See ISDA Primary Membership List, supra note 44.
84
See International Swaps and Derivatives Association, Inc., All About Membership: Associate Membership: List of Associate
Members, at http:// www.isda.org/membership/list_of_associate.html (last visited March 9, 2001) [[hereinafter ISDA Associate
Membership List].
85
See International Swaps and Derivatives Association, Inc., All About Membership: Subscriber Membership: List of Subscriber
Members, at http:// www.isda.org/membership/list_of_subscribers.html (last visited March 9, 2001) [[hereinafter ISDA
Subscriber Membership List].
86
ISDA Primary Membership List, supra note 44.
87
ISDA Associate Membership List, supra note 84.
88
ISDA Subscriber Membership List, supra note 85.
89
Telephone Interview with Richard Grove, Executive Director of ISDA, 1997 to January 2001 (April 6, 2000) [hereinafter Grove
Interview].
90
See International Swaps and Derivatives Association, Inc., ISDA Opens South East Asia Office in Singapore, at http://
www.isda.org/press/singpress1023.html (last visited October 23, 2000).
91
International Swaps and Derivatives Association, Inc.,
http://www.isda.org/wwa/bod.html (last visited January 10, 2001).
92
International Swaps and Derivatives Association, Inc., Who We Are: Year in Review, at http://www.isda.org/wwa/fretro99.html
Who
We
Are:
ISDA
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Board
of
Directors,
at
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(last visited February 15, 2001) [hereinafter ISDA Year in Review]; International Swaps and Derivatives Association, Inc., Who
We Are:Mission, at http:// www.isda.org/wwa/mission.html (last visited January 10, 2001).
93
Tredgett Interview, supra note 10.
94
ISDA Year in Review, supra note 92.
95
International Swaps and Derivatives Association, Inc., Publications: Credit
www.isda.org/publications/pubguide.html #CREDIT (last visited March 9, 2001).
96
See International Swaps and Derivatives Association, Inc., Netting, Collateral & Documentation: Collateral Opinions, at http://
www.isda.org/docproj/collateral_login.html (last visited March 9, 2001) [[hereinafter ISDA Documentation].
97
Telephone Interview with Jeffrey B. Golden, partner, Allen & Overy (April 17, 2000) [hereinafter Golden Interview].
98
See International Swaps and Derivatives Association, Inc., ISDA Master Agreement: Multicurrency - Cross Border (1992),
available at http:www.isda.org/publications/1992mastermc.pdf (last visited February 15, 2001) [hereinafter 1992 ISDA Master].
99
Id.
Support
Documentation,
at
http://
100 Id. § 2(c).
101 Id. §§ 5-6.
102 Romano, supra note 6, at 54.
103 Depending on the ‘method‘ of close-out netting the parties have chosen, A may or may not be required to pay the $10 net amount
to B, if B is the defaulting party. See 1992 ISDA Master, supra note 98, § 6(e). For further discussion of the two methods of
close-out netting, see note 178, infra.
104 ISDA’s attempts to ensure the legal validity of close-out netting are discussed under Part III.B.2, “Netting Opinions,” infra.
105 ISDA Year in Review, supra note 92.
106 McLaughlin, supra note 3, at 136.
107 McLaughlin, supra note 3, at 159-63.
108 ISDA Year in Review, supra note 92; International Swaps and Derivatives Association, Inc., All About Membership, at http://
www.isda.org/membership/index.html (last visited January 10, 2001).
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109 ISDA Year in Review, supra note 92.
110 McLaughlin, supra note 3, at 160-61.
111 International Swaps and Derivatives Association, Inc., ISDA Membership: Information on Member Services, at
http://www.isda.org/a2b.html (last visited February 2, 2000) (Printout on file with author).
112 Romano, supra note 6, at 54.
113 Jeffrey B. Golden, Setting Standards in the Evolution of Swap Documentation, 13 Int’l Fin. L. Rev., 18, 18-19 (May 1994).
114 Ungar, supra note 35, at 81-82; International Swaps and Derivatives Association, Inc., “1991 ISDA Definitions” in Publications:
Definitions, at http://www.isda.org/publications/pubguide.html#DEFINITIONS (last visited March 9, 2001) [hereinafter ISDA
Definitions].
115 See ISDA Definitions, supra note 114.
116 Tredgett Interview, supra note 10.
117 Id. For instance, if one transaction is hedging against another transaction, both of which reference LIBOR as an interest rate, they
will be well hedged if the definition of LIBOR in each contract calls for LIBOR to be quoted from the same source. If the two
contracts determine LIBOR based on different information sources, they will not be as well hedged because a movement in
LIBOR as reported by one source may not be perfectly mirrored in LIBOR as reported by another source.
118 See Ungar, supra note 35, at 81-82; Cunningham Interview, supra note 57.
119 Cunningham Interview, supra note 57.
120 Id. See the discussion of ISDA Master Agreements in “Standard Form Documentation” in Part III.B.1, supra, for a discussion of
how master agreements function.
121 See Golden, supra note 113, at 18.
122 Id.
123 Cunningham Interview, supra note 57.
124 An example of this type of term is the “fallback rate” for LIBOR, which dictates what rates, if any, should be used to calculate
payments on an interest rate swap if the interest rate index chosen as the measure of LIBOR by the parties is unavailable on the
day a payment is to be calculated. For instance, if the parties have chosen the LIBOR rate published on the British Bankers
Association’s LIBOR screen as the basis for calculating payments on their swap, and an emergency of some sort has prevented
the BBA from publishing a LIBOR rate for the date in question, the fallback rate definition would tell the parties where to look
for the LIBOR rate instead, such as the Reuter’s ISDA screen or quotes from individual London banks. Jackson Interview, supra
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note 23.
125 Cunningham Interview, supra note 57.
126 Golden Interview, supra note 97.
127 Lawyers from Sullivan & Cromwell, Davis Polk and Cleary, Gottlieb, Steen & Hamilton represented some of the parties on the
documentation committee. Golden Interview, supra note 97.
128 Cunningham Interview, supra note 57.
129 Id.
130 Golden Interview, supra note 97.
131 Cunningham Interview, supra note 57.
132 Grove Interview, supra note 89.
133 Cunningham Interview, supra note 57; Grove Interview, supra note 89.
134 Cunningham Interview, supra note 57. This drafting approach is discussed in more detail in Part III.D.3, infra.
135 For instance, Dan Cunningham of Cravath and Jeffrey Golden of Allen & Overy each participated in ISDA’s development from
the time of its first informal meetings. Id. They remain primary outside counsel sixteen years later. See id. Joseph Bauman spent
ten years on the board. Telephone Interview with Joseph Bauman, ISDA board member 1989-1999 and chairman 1993-1994
(April 3, 2000) [hereinafter Bauman Interview]. The former in-house General Counsel (now Executive Director) was outside
counsel during the 1990s, and the retiring Executive Director had participated in ISDA drafting sessions as counsel to an ISDA
member. Golden Interview, supra note 97, Grove Interview, supra note 89.
136 This name was changed in 1993 to the International Swaps and Derivatives Association to reflect the development of the industry
and the expanding scope of ISDA’s activities. Jackson Interview, supra note 23. Joe Bauman, who was chairman of the board in
1993, notes that the new name reflected a belief at the board level that ISDA’s role was to represent the interests of the entire
OTC derivatives industry, not just those of dealers. Bauman Interview, supra note 135.
137 See Who We Are, supra note 82.
138 Golden, supra note 113, at 18.
139 Cunningham Interview, supra note 57; Grove Interview, supra note 89. The initial directors were drawn from Shearson Lehman,
Citibank, Bankers Trust, Morgan Guaranty, Salomon Brothers, Kleinworth Benson Cross Finance, Morgan Stanley, Merrill
Lynch, First Boston and Goldman, Sachs. Cunningham Interview, supra note 57.
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140 Cunningham Interview, supra note 57; Telephone Interview with Milton Bellis, Communications Director at ISDA, 1994-2000
(April 5, 2000) [[hereinafter Bellis Interview]; Telephone Interview with Robert Pickel, General Counsel at ISDA, 1997 to
January 2001, Executive Director of ISDA, January 2001 to present (April 10, 2000) [hereinafter Pickel Interview].
141 As the industry grew, new derivative products developed in addition to swaps. ISDA’s coverage shifted to include these new OTC
derivative instruments. Jackson Interview, supra note 23.
142 International
Swaps and Derivatives Association, Inc., All About Membership: By Laws
http://www.isda.org/membership/bylaws.html, Art. IV (last visited March 9, 2001) [hereinafter ISDA By-Laws].
[sic],
at
143 The right to vote in elections was not extended to the Associate and Subscriber membership categories when they were added in
the late 1980s, so only Primary Members cast votes. Bauman Interview, supra note 135.
144 In practice, more than half of the board is usually up for election since all board vacancies due to resignations are replaced at the
next annual meeting, regardless of the term of the director who resigned. Bauman Interview, supra note 135. Resignations from
the board are quite common. The reason for this is that board seats are tied to both individuals and institutions. Thus, if a board
member changes jobs, even to another ISDA member, he or she loses the board seat. In addition, their institution loses its board
seat, and may not replace them with another representative. The board may then choose to appoint a replacement individual from
among the primary membership. Even if the empty seat is filled in this manner, however, the seat will be re-filled at the next
annual meeting. Id.
145 Id.
146 Id. Bauman, who was a director from 1989 to 1999 and chairman of the board from 1993 to 1994, jokingly notes that the
board-election process was run “like the Soviet Government.” If there were ten open board seats, members were presented with
ten candidates. Id.
147 Telephone Interview with Bradley Ziff, Executive Director of ISDA, 1988-1993 (April 3, 2000) [hereinafter Ziff Interview];
Cunningham Interview, supra note 57.
148 ISDA Market Survey, supra note 52.
149 Id.
150 Id.
151 As the market in swaps matured during the 1980s and early 1990s, the variety of instruments traded by ISDA member dealers
expanded to include OTC derivatives that were not technically swaps, such as OTC options. As a result, ISDA rules and
documents began referring to “OTC derivatives” where they would previously have referred to “swaps.” Jackson Interview, supra
note 23.
152 ISDA By-Laws, supra note 142, at Article III; Cunningham Interview, supra note 57.
153 Ziff Interview, supra note 147.
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154 Bauman Interview, supra note 135.
155 ISDA Primary Membership List, supra note 44.
156 ISDA Associate Membership List, supra note 84.
157 ISDA Subscriber Membership List, supra note 85.
158 Jackson Interview, supra note 23; Bauman Interview, supra note 135.
159 Ziff Interview, supra note 147.
160 E.g., credit derivatives.
161 E.g., the energy sector.
162 Bellis Interview, supra note 140.
163 Pickel Interview, supra note 140.
164 Id.
165 Bauman Interview, supra note 135; Golden Interview, supra note 97; Bellis Interview, supra note 140.
166 Golden Interview, supra note 97.
167 Id.
168 Golden, supra note 113, at 19.
169 Cunningham Interview, supra note 57.
170 Id. In 1986, Dan Cunningham moved to Cravath’s London office, where he and Jeffrey Golden worked together on the 1987
ISDA Master Agreement. During this period, prior to Golden’s move to Allen & Overy in 1994, Linklaters participated in the
process as ISDA’s English counsel. Id.
171 Golden, supra note 113, at 19.
172 The 1992 ISDA Master Agreement, which updated these contracts, is also two agreements, one designed for strictly local,
single-currency transactions, and the other capable of handling cross-border, multi-currency transactions. See ISDA
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Documentation, supra note 96.
173 Discussed in Part III.C, supra.
174 Golden Interview, supra note 97.
175 These provisions make it a default under the master agreement for a party to default on a separate, unrelated obligation to its
counterparty, or even to third parties. For instance, missing a payment on an unrelated loan owed to the counterparty could be
considered a default under the cross-default provisions of the master agreement. 1992 ISDA Master, supra note 98, §§
5(a)(v)-(vi).
176 Golden Interview, supra note 97.
177 Id.
178 The re-draft in the early 1990s of the 1987 ISDA Master Agreement was motivated by several factors. First, the market had
developed new financial products. As new OTC derivative products became available, and as it became clear that new products
would continue to be designed, it became desirable to design a master agreement with maximum flexibility, adding provisions, for
instance, for physical settlement. The earlier agreement only provided for cash payments, such as those exchanged in interest rate
swaps. Physical settlement provisions allow the agreement to be used for the documentation of contracts such as certain types of
stock options, in which one party settles at the end by supplying the other party with physical stock. In addition, regulators were
putting pressure on the industry to modify the close-out netting provisions in the agreement. In the 1987 Master Agreement
close-out netting provisions (referred to in the industry as the “first method”), if the net value of transactions terminated upon
default were calculated to be in favor of the defaulting party, no payment needed to be made by the non-defaulting party. By
defaulting, a party forfeited any net value it would otherwise have had under the master agreement. U.S. regulators preferred a
system in which both parties, not just the defaulting party, were obligated to pay any net obligation to their counterparty. The
1992 ISDA Master Agreement was drafted so as to provide for this ‘second method‘ of close-out netting as an option for
contracting parties. Tredgett Interview, supra note 10.
179 These definitions centered around payment calculations, and updated definitions released in the late eighties, so as to
accommodate the new types of derivatives that were proliferating in the early nineties. Jackson Interview, supra note 23; Golden
Interview, supra note 97.
180 Bauman Interview, supra note 135.
181 See, e.g. Regulation of Over-the-Counter Derivatives Market:Hearing before the House Comm. on Agric., Subcomm. on Risk
Mgmt. & Specialty Crops (June 10, 1998) (Statement of Joseph Bauman, Senior Vice-President, Bank of America).
182 Romano, supra note 6, at 54.
183 Bauman Interview, supra note 135.
184 Activities to increase legal certainty have included hiring counsel to obtain legal opinions for various jurisdictions as to the
enforceability of key provisions of the ISDA Master Agreement, such as close-out netting. Jackson Interview, supra note 23.
Another legal certainty concern was whether certain parties had the power to enter into binding swap agreements. Bauman
Interview, supra note 135. In the early 1990s, the London borough of Hammersmith & Fulham was facing large losses on interest
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rate swaps and sued in court, arguing that the transactions were void. It claimed that local government officials did not have the
authority to enter into this type of speculative contract. The English court agreed, and the U.S. swap dealer went unpaid. Ungar,
supra note 35, at 123. Some of ISDA’s efforts at establishing legal certainty are aimed at identifying and avoiding previously
unforeseen problems such as this one. Bauman Interview, supra note 135. For example, in 1996, following the challenges to
derivatives contracts in the Procter & Gamble and Gibson Greeting cases based on dealer fiduciary or advisory duties, ISDA
released standardized wording to be incorporated into Master Agreements, designed to cut off further attack of the agreements by
this route by explicitly excluding fiduciary relationships reliance and asserting each party’s ability to understand the instruments.
Gay & Medero, supra note 80, at 234-35.
185 ISDA’s current primary tasks include updating and consolidating of all of its existing standard documentation and continuing the
expansion of its documentation to encompass other products such as the recently released credit-derivatives documentation.
Tredgett Interview, supra note 10. (Credit derivatives are derivative instruments that are used to hedge against changes in a
counterparty’s creditworthiness. Just as an interest-rate swap protects against adverse changes in interest rates, credit derivatives
will pay if certain credit- and default-related events occur.) Telephone Interview with Nina Hval, U.S. lawyer, Allen & Overy
(April 3, 2000) [hereinafter Hval Interview]. ISDA is also focusing on the further development of risk management techniques,
which have become a particular concern following such events as the recent Russian and Asian financial crises and the failure of
Long Term Capital Management, a massive derivative-based hedge fund. Provisions clarifying or altering the results of illegality,
impracticability, and force majeure may be added to the ISDA Master Agreement as part of this process. Tredgett Interview, supra
note 10. ISDA is also aiding in the expansion of OTC derivatives into emerging markets. Grove Interview, supra note 89. The
establishment of standard market practices will also continue at ISDA as new financial products emerge and as global political
and economic factors change over time. Id.
186 Bellis Interview, supra note 140.
187 Id.; Jackson Interview, supra note 23; Bauman Interview, supra note 135.
188 Bellis Interview, supra note 140.
189 Ziff Interview, supra note 147.
190 Bellis Interview, supra note 140; Jackson Interview, supra note 23.
191 Ziff Interview, supra note 147. Membership in the organization itself has continued to grow steadily. It increased by
approximately 15% in 1999, drawing new members primarily from secondary and emerging markets. Bellis Interview, supra note
140. The board has increased in size along with the organization and now can include up to 25 members. ISDA By-Laws, supra
note 142, at Art. VI §3.
192 Ziff Interview, supra note 147.
193 Bauman Interview, supra note 135.
194 Id; Bellis Interview, supra note 140.
195 Bellis Interview, supra note 140; Telephone Interview with Corrinne Greasley, Head of Administration, ISDA (February 23,
2001).
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196 Bauman Interview, supra note 135.
197 Pickel Interview, supra note 140.
198 Cunningham Interview, supra note 57.
199 Ziff Interview, supra note 147.
200 Id.
201 Grove Interview, supra note 89.
202 Id.
203 Id.; Bellis Interview, supra note 140; Bauman Interview, supra note 135.
204 Bellis Interview, supra note 140; Jackson Interview, supra note 23.
205 Grove Interview, supra note 89.
206 Id.
207 Golden Interview, supra note 97.
208 Bauman Interview, supra note 135.
209 Jackson Interview, supra note 23.
210 See
International Swaps and Derivatives Association,
http://www.isda.org/wwa/bod.html (last visited March 9, 2001).
Inc.,
Who
We
Are:
Board
of
Directors,
at
211 Id.; Grove Interview, supra note 89; Hval Interview, supra note 185.
212 Bellis Interview, supra note 140.
213 Jackson Interview, supra note 23; Tredgett Interview, supra note 10.
214 For instance, meeting sites were set up in New York and London for some Credit Derivatives Committee meetings. Generally,
ISDA has found that the most effective way to run these tele-conference meetings is to have each site meet separately, with
periodic link-ups between the two sites to report on progress and share ideas. Pickel Interview, supra note 140.
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215 Id.; Tredgett Interview, supra note 10.
216 Pickel Interview, supra note 140; Hval Interview, supra note 185.
217 Tredgett Interview, supra note 10.
218 Hval Interview, supra note 185.
219 Id.
220 Id.
221 Grove Interview, supra note 89. Richard Tredgett of Allen & Overy notes that the documentation committees that he has worked
with have been cordial and “consensus-oriented.” Tredgett Interview, supra note 10.
222 Pickel Interview, supra note 140.
223 Hval Interview, supra note 185.
224 Id.
225 Pickel Interview, supra note 140.
226 Jackson Interview, supra note 23.
227 Tredgett Interview, supra note 10.
228 See Robert Rice, A Question of Standards, Fin. Times, Nov. 22, 1994. Variations on these models certainly exist. For instance,
one other option is to include “bridge” provisions within individual master agreements. These provisions would link those master
agreements to one another. Tredgett Interview, supra note 10.
229 Tredgett Interview, supra note 10.
230 Id.
231 Hval Interview, supra note 185.
232 Tredgett Interview, supra note 10.
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233 Hval Interview, supra note 185.
234 Id.
235 ISDA Year in Review, supra note 92.
236 Grove Interview, supra note 89.
237 Id.; Golden Interview, supra note 97.
238 Golden Interview, supra note 97.
239 Bauman Interview, supra note 135.
240 Cunningham Interview, supra note 57; Golden Interview, supra note 97.
241 Golden Interview, supra note 97; Bauman Interview, supra note 135; Bellis Interview, supra note 140.
242 Cunningham Interview, supra note 57.
243 Pickel Interview, supra note 140.
244 For a discussion of this process, see Part III.E.1, “Changing the Model,” supra.
245 Cunningham Interview, supra note 57.
246 Id.
247 Bauman Interview, supra note 135.
248 Golden Interview, supra note 97.
249 Bauman Interview, supra note 135; Hval Interview, supra note 185.
250 Golden Interview, supra note 97.
251 Id.
252 Id.
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253 Id.
254 See discussions of ISDA’s negotiation and drafting processes in “Beginnings,” Part III.C.1, supra; “Committees,” Part III.D.2,
supra; and “Current Drafting Processes,” Part III.E.2, supra.
255 See ISDA Documentation, supra note 96.
256 Golden Interview, supra note 97.
257 Id.
258 This is another instance in which testing the appropriateness of a market consensus is valuable. A practice may be ingrained in the
market, but it is not necessarily the ideal practice, in light of technological or global developments.
259 Romano, supra note 6, at 54; Golden Interview, supra note 97.
260 Discussed in Part III.C.1, “Beginnings,” supra.
261 Tredgett Interview, supra note 10.
End of Document
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