Non-Standardized Derivatives are financial contracts whose terms are customized between two counterparties, rather than traded on an organized exchange with predefined specifications. These Over-The-Counter (OTC) instruments are tailored to specific needs, offering flexibility in underlying assets, notional amounts, maturities, and payment structures. In crypto, they often involve bespoke agreements on digital assets or their derivatives.
Mechanism
The mechanism involves direct negotiation between two parties to define all contractual terms, including collateral requirements, valuation methodologies, and dispute resolution processes. Execution occurs bilaterally, outside of central clearing houses, necessitating robust legal documentation like ISDA Master Agreements and collateral agreements. Pricing is typically determined through a Request for Quote (RFQ) process or direct negotiation, reflecting the bespoke nature of the agreement.
Methodology
The strategic advantage of non-standardized derivatives lies in their adaptability, allowing institutions to construct precise hedging or speculative strategies that are unavailable on standardized exchanges. While offering tailored solutions, they introduce higher counterparty credit risk and liquidity risk due to their illiquid nature and lack of central clearing. Effective risk management requires comprehensive credit assessment, robust collateralization frameworks, and diligent legal agreement management to mitigate these inherent complexities.
Multilateral netting applies to non-standardized derivatives through portfolio compression, a process that algorithmically terminates offsetting contracts.
We use cookies to personalize content and marketing, and to analyze our traffic. This helps us maintain the quality of our free resources. manage your preferences below.
Detailed Cookie Preferences
This helps support our free resources through personalized marketing efforts and promotions.
Analytics cookies help us understand how visitors interact with our website, improving user experience and website performance.
Personalization cookies enable us to customize the content and features of our site based on your interactions, offering a more tailored experience.
