It is possible to structure derivatives whose performance concludes in all sorts of ways. However, typical derivatives are cash-settled: at the conclusion of the contract, a sum of money changes hands, and nothing else happens.


The outcome of a cross-currency swap at any particular payment date, for example, will be that one side has to pay the other side money reflecting where the exchange rate has got to on that date. One side gains, while the other simply loses, and the amount in both cases is identical. This reflects the abstraction of both parties’ interests into pure money. More than anything else, it is what distinguishes derivatives from other contracts.


In derivatives, there is no exchange, but only a payment in one direction or the other. Because of this feature, derivatives are classic zero-sum games, i.e. procedures where the sum of benefits is not increased, but only shifted.


In normal commercial contracts, by contrast, exchange is involved – typically, money is exchanged for goods or services. It is because of this that commercial contracts are not zero-sum. Following my visit to the bakery to buy a loaf, my resulting benefit is greater than it would have been if I had just hung on to the money, and the benefit to the baker is greater than if he had just hung on to the bread. The sum of benefits is increased, regardless of considerations such as whether the price was “fair” or not.


It is the absence of exchange that makes “netting” possible in a derivatives contract. Netting is the procedure whereby, on any payment date, the obligations of the two parties are set off against one another with the consequence that only one payment, in only one direction, takes place. This obviously cannot happen with commercial contracts, since they typically involve exchange, i.e. the exchange of disparate items. As the Master Agreement makes clear, netting is dependent on payments being due from both parties on the same date, in the same currency, and in respect of the same transaction. If those conditions are fulfilled, “the party by which the larger … amount would have been payable [is obliged] to pay to the other party the excess of the larger […] amount over the smaller […] amount”.1


1„ISDA 2002 Master Agreement“,  s. 2 (c).

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