Legal Aspects and Operations of Derivatives Trading

Abstract

An OTC derivative transaction is a legal contract between two trading counterparties. In order for a derivative transaction to be executed, both parties have to agree on all the legal terms. The contract would cover a variety of aspects, including terms relating to:

• Specific derivative transaction payoffs, such as cash flow schedules, payment index, coupon frequency, holiday calendar, etc.

• Options exercise and terminations, including discretionary exercises and mandatory terminations, as well as how to determine the termination values and the settlement procedures.

• Derivatives operations, such as settlement, transfer provision, collaterals types, currencies, thresholds, and margin grace period.

• Counterparty credit and default: what situation would be regarded as default, what would be the legal jurisdiction, and the seniority of the derivative transaction in the payment waterfall, etc.