Derivative Contracts: Where is your Counterparty and why should you Care?

A recent Wall Street Journal article, entitled “Big Banks Make Swaps a Foreign Affair,” serves as a reminder for investors who are parties to derivative contracts that the devil is in the details.  The article suggests that U.S. banks, including Bank of America, Citi, Goldman Sachs, JPMorgan Chase and Morgan Stanley are changing the terms of swap agreements so that the U.S. parent bank is no longer the guarantor under the derivatives contract.

The article also suggests that, without a tie to a U.S. parent, the derivatives contract will not fall under U.S. jurisdiction, and could avoid Dodd-Frank rules altogether.  Although there may be other bases for U.S. jurisdiction, investors in bad derivatives contracts with offshore entities without any tie to a U.S. bank may be face very serious problems enforcing those agreements, or availing themselves of investor protections under U.S. laws.  This added risk should be carefully weighed by investors entering into these derivative contracts, and considered by the investors as a negative impact on the valuation of the derivative contracts.