In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets.
A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting. The buyer of the CDS makes a series of payments to the seller and, in exchange, may expect to receive a payoff if the asset defaults.
The Commodity Futures Modernization Act of 2000 (CFMA) is United States federal legislation that ensured financial products known as over-the-counter (OTC) derivatives remained unregulated. It was signed into law on December 21, 2000 by President Bill Clinton. It clarified the law so most OTC derivative transactions between "sophisticated parties" would not be regulated as "futures" under the Commodity Exchange Act of 1936 (CEA) or as "securities" under the federal securities laws. Instead, the major dealers of those products would continue to have their dealings in OTC derivatives supervised by their federal regulators under general "safety and soundness" standards. The Commodity Futures Trading Commission's (CFTC) desire to have "functional regulation" of the market was also rejected. Instead, the CFTC would continue to do "entity-based supervision of OTC derivatives dealers". The CFMA's treatment of OTC derivatives such as credit default swaps has become controversial, as those derivatives played a major role in the financial crisis of 2008 and the subsequent 2008–2012 global recession.
The International Swaps and Derivatives Association is a trade organization of participants in the market for over-the-counter derivatives.
Over-the-counter (OTC) or off-exchange trading or pink sheet trading is done directly between two parties, without the supervision of an exchange. It is contrasted with exchange trading, which occurs via exchanges. A stock exchange has the benefit of facilitating liquidity, providing transparency, and maintaining the current market price. In an OTC trade, the price is not necessarily publicly disclosed.
The Depository Trust & Clearing Corporation (DTCC) is an American post-trade financial services company providing clearing and settlement services to the financial markets. It performs the exchange of securities on behalf of buyers and sellers and functions as a central securities depository by providing central custody of securities.
In banking and finance, clearing denotes all activities from the time a commitment is made for a transaction until it is settled. This process turns the promise of payment into the actual movement of money from one account to another. Clearing houses were formed to facilitate such transactions among banks.
Security market is a component of the wider financial market where securities can be bought and sold between subjects of the economy, on the basis of demand and supply. Security markets encompasses stock markets, bond markets and derivatives markets where prices can be determined and participants both professional and non professional can meet.
Markets in Financial Instruments Directive 2014 commonly known as MiFID 2, is a legal act of the European Union. Together with Regulation (EU) No 600/2014 it provides a legal framework for securities markets, investment intermediaries, and trading venues. The directive provides harmonised regulation for investment services of the member states of the European Economic Area — the EU member states plus Iceland, Norway, and Liechtenstein. Its main objectives are to increase competition and investor protection, and level the playing field for market participants in investment services. It repeals Directive 2004/39/EC.
The Undertakings for Collective Investment in Transferable Securities Directive (UCITS) 2009/65/EC is a consolidated EU directive that allows collective investment schemes to operate freely throughout the EU on the basis of a single authorisation from one member state. EU member states are entitled to have additional regulatory requirements for the benefit of investors.
Options Clearing Corporation (OCC) is a United States clearing house based in Chicago. It specializes in equity derivatives clearing, providing central counterparty (CCP) clearing and settlement services to 16 exchanges. Started by Wayne Luthringshausen and carried on by Michael Cahill. Its instruments include options, financial and commodity futures, security futures and securities lending transactions.
In law, set-off or netting are legal techniques applied between persons or businesses with mutual rights and liabilities, replacing gross positions with net positions. It permits the rights to be used to discharge the liabilities where cross claims exist between a plaintiff and a respondent, the result being that the gross claims of mutual debt produce a single net claim. The net claim is known as a net position. In other words, a set-off is the right of a debtor to balance mutual debts with a creditor.
A central clearing counterparty (CCP), also referred to as a central counterparty, is a financial institution that takes on counterparty credit risk between parties to a transaction and provides clearing and settlement services for trades in foreign exchange, securities, options, and derivative contracts. CCPs are highly regulated institutions that specialize in managing counterparty credit risk.
Collateral has been used for hundreds of years to provide security against the possibility of payment default by the opposing party in a trade. Collateral management began in the 1980s, with Bankers Trust and Salomon Brothers taking collateral against credit exposure. There were no legal standards, and most calculations were performed manually on spreadsheets. Collateralisation of derivatives exposures became widespread in the early 1990s. Standardisation began in 1994 via the first ISDA documentation.
LCH is a British clearing house group that serves major international exchanges, as well as a range of OTC markets. The LCH Group consists of two subsidiaries: LCH Ltd and LCH SA. Based on 2012 figures, LCH cleared approximately 50% of the global interest rate swap market, and was the second largest clearer of bonds and repos in the world, providing services across 13 government debt markets. In addition, LCH clears a broad range of asset classes including: commodities, securities, exchange traded derivatives, credit default swaps, energy contracts, freight derivatives, interest rate swaps, foreign exchange and Euro and Sterling denominated bonds and repos.
The ISDA Master Agreement, published by the International Swaps and Derivatives Association, is the most commonly used master service agreement for OTC derivatives transactions internationally. It is part of a framework of documents, designed to enable OTC derivatives to be documented fully and flexibly. The framework consists of a master agreement, a schedule, confirmations, definition booklets, and credit support documentation.
The European Market Infrastructure Regulation (EMIR) is an EU regulation aimed at reducing systemic counterparty and operational risk and thereby prevent future financial system collapses. Its focus is regulation of over-the-counter (OTC) derivatives, central counterparties and trade repositories. It provides steer on reporting of derivative contracts, implementation of risk management standards and common rules for central counterparties and trade repositories.
Financial law is the law and regulation of the commercial banking, capital markets, insurance, derivatives and investment management sectors. Understanding financial law is crucial to appreciating the creation and formation of banking and financial regulation, as well as the legal framework for finance generally. Financial law forms a substantial portion of commercial law, and notably a substantial proportion of the global economy, and legal billables are dependent on sound and clear legal policy pertaining to financial transactions. Therefore financial law as the law for financial industries involves public and private law matters. Understanding the legal implications of transactions and structures such as an indemnity, or overdraft is crucial to appreciating their effect in financial transactions. This is the core of financial law. Thus, financial law draws a narrower distinction than commercial or corporate law by focusing primarily on financial transactions, the financial market, and its participants; for example, the sale of goods may be part of commercial law but is not financial law. Financial law may be understood as being formed of three overarching methods, or pillars of law formation and categorised into five transaction silos which form the various financial positions prevalent in finance.
European company law is a part of European Union law, which concerns the formation, operation and insolvency of companies in the European Union. The EU creates minimum standards for companies throughout the EU, and has its own corporate forms. All member states continue to operate separate companies acts, which are amended from time to time to comply with EU Directives and Regulations. There is, however, also the option of businesses to incorporate as a Societas Europaea (SE), which allows a company to operate across all member states.
A clearing house is a financial institution formed to facilitate the exchange of payments, securities, or derivatives transactions. The clearing house stands between two clearing firms. Its purpose is to reduce the risk of a member firm failing to honor its trade settlement obligations.
