Negotiate the Terms First…then Negotiate the Price
Every interest rate swap or interest rate cap agreement is documented by a contract framework consisting of the following three items:
- ISDA Master Agreement– a standard agreement used by every bank that defines terms, notices, remedies, and so forth.
- ISDA Schedule– a rider to the Master Agreement, defining optional terms. The Schedule elaborates contract terms regarding default, early termination, transfers etc. All of these items are negotiable, and therefore critical to a borrower obtaining the most advantageous terms.
- Confirmation– describes the economic details of an individual interest rate swap transaction. DerivGroup will make certain that the Confirmation accurately matches the terms of the transaction that was negotiated, and that there are no errors or extraneous items.
Key Negotiating Points
When entering into an ISDA Agreement it is important to consider the possible “what-ifs”. After a swap’s rate is set, its market value will change to the benefit of either the borrower or the bank…as interest rates either rise or fall. Below are four important issues that should be negotiated prior to entering into a swap.
Early Termination – As the value of the swap changes over time, it will become either an asset or a liability for the borrower. If interest rates have declined (or risen), the borrower will either owe the bank a penalty (or vice versa) if it terminates the swap (or in event of a default). How and when the termination value is paid needs to be negotiated.
Bank Credit Risk – There is a risk the bank may default on its obligations under the interest rate swap. If this occurs, the borrower loses the swap, which could have considerable value.
Matching of Terms – The terms of the swap and the loan need to match so that the swap can function properly. A mismatch between the two could negatively impact the borrower.
Transfer or Cancellation – Typically the ISDA agreement does not allow for a transfer or early cancellation of a swap, which can be negotiated.
Before entering into an ISDA Agreement, contact DerivGroup to help negotiate the terms that align with your particular objectives.