Master Agreement

A master agreement is, in financial markets, a contract that two counterparties sign once to govern every transaction of a particular kind that they later enter into with each other. It sets out the general legal and credit terms, such as representations, payment mechanics, events of default and what happens on termination, so that each individual trade needs only a short confirmation of its economic details. Master agreements are the legal foundation of the over-the-counter derivatives, repo and securities lending markets.

The best known is the ISDA Master Agreement, published by the International Swaps and Derivatives Association for OTC derivatives. Similar standard forms exist for other products and are published by trade associations rather than regulators. Master agreements are also used in ordinary commerce, for example master services agreements with suppliers, but in finance the term almost always refers to these trading documents.

A master agreement relationship is built from several layers. The pre-printed master agreement contains standard terms that parties do not alter. A schedule, negotiated between the two parties, records their elections and amendments: which entities and branches are covered, which termination events apply, governing law and tax representations. Each trade is then evidenced by a confirmation that incorporates the master by reference, as described under derivative trade confirmation. Standard definitions booklets supply the meaning of product terms.

Credit support documents sit alongside. The most common is the credit support annex, a form of bilateral collateral agreement under which the parties exchange collateral against the net value of their trades. Guarantees from parent companies may also be listed as credit support.

The central legal idea is that the master agreement and all confirmations under it form a single agreement. If one party defaults, the other may terminate every outstanding transaction, value each one, and combine the results into one net amount payable by one side. This is close-out netting, and it prevents an insolvency official from enforcing the contracts that favour the failed party while rejecting those that do not.

The effect on risk is large. Without netting, a dealer's exposure to a counterparty would be the sum of all trades with positive value; with it, exposure is the net figure, which is typically a small fraction of the gross. Bank capital rules recognise this reduction in counterparty risk only where the bank holds legal opinions confirming that netting is enforceable in the relevant jurisdictions. Trade associations commission such opinions for their members, and many countries have passed specific netting legislation to give certainty.

Different markets use different standard documents:

• ISDA Master Agreement. Published in 1992 and revised in 2002, it covers swaps, options and forwards across interest rates, currencies, credit, equities and commodities. The 2002 version changed the method for valuing terminated trades to a single close-out amount.
• Global Master Repurchase Agreement (GMRA). Published by the International Capital Market Association together with the Securities Industry and Financial Markets Association, it governs the repurchase agreement market outside the United States.
• Global Master Securities Lending Agreement (GMSLA). Published by the International Securities Lending Association, it governs securities loans and their collateral.
• Domestic forms. National documents such as the German and French master agreements for financial transactions, and the US master repurchase and securities lending forms, serve local markets.

The agreement lists the circumstances that allow one party to end the relationship. Events of default are fault-based and typically include failure to pay or deliver, breach of agreement, misrepresentation, default under other borrowing above a threshold, and insolvency. Termination events are generally no-fault, such as a change in law that makes performance illegal or a tax change. Following an event, the non-defaulting party may designate an early termination date, after which the trades are valued and the net amount calculated, taking account of any margin already held.

The collapse of Lehman Brothers in 2008 tested these provisions on a very large scale and led to litigation over valuation methods and over clauses that suspend payments to a defaulting party. Resolution regimes introduced since then allow authorities to impose a short stay on termination rights when a bank is being resolved, and industry protocols extend those stays to cross-border contracts.

Post-crisis reforms moved standardised derivatives to central counterparty clearing, where the clearing house rulebook replaces the bilateral master for cleared trades. Bilateral master agreements remain necessary for uncleared trades, and regulatory margin rules have required new collateral documentation under them. Operational duties that depend on the agreement include portfolio reconciliation and dispute resolution, while trade compression reduces the number of trades outstanding under each master.

• International Swaps and Derivatives Association (ISDA)
• International Capital Market Association (ICMA)