An Analysis of Interest Rate and Currency Swaps

Companies in the United Kingdom developed currency swaps as a-means of obtaining off-shore financing in the face of restrictive exchange controls in the mid-1970s.tFrom this particularized context, swap financing has evolved into a 200 billion dollar industry and a driving force in international capital markets.Despite the development of swaps and their continued use as a means of obtaining economic results which might otherwise be barred by restrictive governmental regulations, the structure and form of swaps evolved free from governmental regulation through negotiations between separate parties on a case-by-case basis.A legal discussion of swaps is thus primarily an analysis of contractual provisions.This article will first describe swaps and some of their uses.Next, it will discuss the credit exposure incurred by parties to a swap agreement, the documentation required for swaps, certain regulatory and tax implications of swaps, and some of the principal legal risks involved in enforcing swap agreements.The article will conclude with a description of several issues currently faced by leading swaps institutions including the transfer and reduction of swap risk and the securitization of swaps. I. Description of SwapsA typical interest rate swap involves an agreement between two parties.The first party agrees to pay to the second party an amount equal to the interest which would accrue on an agreed amount during a given period at one type of interest rate.The second party agrees to pay to the first party an amount equal to the interest which would accrue on that agreed amount at another type of interest rate.Virtually all common interest rates are regularly swapped: fixed, prime, London Interbank Offered Rate (LIBOR), 2 bankers accept-* Partner, Sidley & Austin, London, England.Many of the views and conclusions, with respect to swaps, expressed herein parallel those expressed in Recent Innovations in International Banking, (Study Group established by the Central Banks of the Group of Ten Countries), April 1986, published after submission of this article in March, 1986.