Managing a company’s cash and financial assets equates to managing a company’s risks. This is axiomatic. Derivatives—and related contractual arrangements—have been widely used for risk management purposes in the financial markets for many years. This is common knowledge.

Nevertheless, in our experience, there is a wide range of familiarity and expertise among corporate treasury teams (broadly defined to include the in-house attorneys who support such teams) when it comes to the use of derivatives for risk management purposes, in general, and legal issues related to their use, in particular.

At one end of the spectrum is the extremely sophisticated corporate treasury team supported by one or more dedicated in-house attorneys with deep experience negotiating derivatives trading documentation. This scenario, while ideal, is not very common, even among some of the largest companies.

At the other end of the spectrum is a solo corporate treasurer or chief financial officer using derivatives for the first time and working without the support of a dedicated attorney (in-house or otherwise). This scenario, while less than ideal, is also more common.

And, as is often the case in life, the “somewhere-in-between” is the most common: a corporate treasurer has some exposure to derivatives and is supported by an attorney with general corporate and securities experience, but less in-depth derivatives expertise. A variation on this theme is that a corporate treasury team with experience using one particular type of derivative for a particular strategy is considering the use of a new, more complex derivative or strategy.

Regardless of the level of expertise, many corporate treasury clients ask a very similar question when they consider their use of derivatives, “How should our company think about the legal issues related to the use of derivatives for hedging and risk management purposes?”

The short answer to that question is, “In a manner that aligns with the representations that your company is making in the relevant trading agreement.”

For example, consider the following representations from paragraph 6 of the Master Securities Forward Transaction Agreement (“MSFTA”) as published by the Securities Industry and Financial Markets Association (“SIFMA”) in 2012 (last accessed on December 8, 2023):

Each party represents and warrants to the other party that (i) it is duly authorized to execute and deliver this Agreement, to enter into Transactions contemplated hereunder and to perform its obligations hereunder and has taken all necessary action to authorize such execution, delivery and performance; (ii) it will engage in such Transactions as principal (or, if agreed in writing, in the form of an annex hereto or otherwise, in advance of any Transaction by the other party hereto, as agent for a disclosed principal); (iii) the person signing this Agreement on its behalf is duly authorized to do so on its behalf (or on behalf of any such disclosed principal); (iv) it has obtained all authorizations of any governmental body required in connection with this Agreement and the Transactions hereunder and such authorizations are in full force and effect; and (v) the execution, delivery and performance of this Agreement and the Transactions hereunder will not violate any law, ordinance, charter, by-law or rule applicable to it or any agreement by which it is bound or by which any of its assets are affected. On the Trade Date for any Transaction each party shall be deemed to repeat all of the foregoing representations made by it. [Emphasis added]

As applied to the question presented above, a corporate treasurer or treasury team can use the foundational concepts in these representations as the framework for developing a basic checklist that, in turn, can serve as the building blocks of an effective risk management program. The following are sample questions that can be asked as part of the process of developing such a program:

• Have we obtained the necessary board and senior executive approvals?
• Do our corporate resolutions reflect these approvals?
• Do we have effective compliance policies and procedures?
• What limits will we be putting around permitted types/uses of derivatives?
• Is our internal audit function sufficiently trained to review our usage?
• Will we rely on an independent adviser to develop our hedging program?
• How does/will our corporate structure relate to our hedging program?
• Do we have sufficient oversight of our authorized signers process?
• Have we reviewed our constituent documents for permissibility?
• Have we obtained all necessary regulatory approvals?
• Have we made all requisite disclosures?

Of course, this is a representative list and the development of an effective hedging and risk management program will often have to take into consideration potentially complex regulatory and corporate governance requirements. Accordingly, corporate treasurers should seek the advice of qualified counsel and professionals from other disciplines, such as an accounting firm.

(Note: The author would like to thank Stephen A. Keen, formerly the General Counsel of Federated Investors, Inc. (now Federated Hermes, Inc.), for pointing out many years ago the utility of basic representations in published master trading agreements, like the MSFTA. The lesson from many years ago has not been lost and is being used down to the present day, including in the preparation of this blog post.)