What Is a Long Form Confirmation?
If you’ve entered into an interest rate swap, you probably recall signing something called an “ISDA.” This document is actually comprised of three separate components:
- ISDA Master Agreement – This is a form document that governs all types of swap contracts.
- ISDA Schedule – This is used to alter or add to the terms of the ISDA Master Agreement.
- Confirmation - This contains the economic terms of the swap transaction and can also be used to further alter or modify the terms of the ISDA Master Agreement and ISDA Schedule.
Oftentimes, these documents are described by banks as being industry standard, boilerplate documents that are not subject to change. In reality, the ISDA is highly negotiable and contains critical provisions that could negatively impact the borrower in the event of a default or dispute.
But what about other derivatives like interest rate caps? In most cap transactions with a third-party bank, an ISDA Master Agreement or Schedule isn’t executed. Instead, most third-party caps are governed by a “long form confirmation.”
The long form confirmation serves a similar purpose to an ISDA Schedule and can be negotiated to ensure the agreement is favorable for the cap purchaser. ISDA definitions are still incorporated into the long form confirmation, but rather than signing an ISDA, the counterparties are deemed to have entered into an ISDA Master Agreement, with the terms of that agreement and specific provisions only altered through the long form confirmation instead of by the ISDA Schedule.
If you’re executing a cap directly with the lender and don’t involve an advisor, lenders will in many cases opt for a boilerplate version of the long form confirmation that doesn’t contain some of the desired language for the cap purchaser. Advisors negotiate the long form confirmation through the bid package, which in addition to the economic terms of the hedge, should include specific language around what provisions should be included in the confirmation. Some of those provisions include:
- Bank Ratings Downgrade – This helps limit the cap purchaser’s exposure if the bank’s credit ratings fall below a certain level or are otherwise withdrawn.
- Events of Default – As the bank has already received its full payment for the cap, the cap purchaser should consider requesting that certain events of default not apply to the cap purchaser.
- Set-Off – The cap purchaser should request that set-off not apply.
If you’re working with your lender on an upcoming rate cap and are unsure of all the considerations that should go into the documentation, reach out to the experts at pensfordteam@pensford.com or (704) 887-9880. For a quick estimate on the cost of your next cap, check out our cap pricer.
