ISDRs

ISDRs, or Interest Rate Swaps, are financial derivative contracts. They are agreements between two parties to exchange a series of interest rate payments over a specified period. Typically, one party agrees to pay a fixed interest rate on a notional principal amount, while the other party agrees to pay a floating interest rate, usually tied to a benchmark like LIBOR or SOFR, on the same notional amount. The principal itself is not exchanged, only the interest payments based on it.

The primary purpose of an ISDR is to manage interest rate risk. Companies or financial institutions might use them to convert floating-rate debt to fixed-rate debt, or vice versa. For example, a company with a loan that has a variable interest rate might enter into a swap to pay a fixed rate, thereby gaining certainty about its future borrowing costs. Conversely, an investor expecting interest rates to fall might enter a swap to pay a fixed rate and receive a floating rate, hoping to benefit from lower future payments.

ISDRs are traded Over-The-Counter (OTC), meaning they are customized contracts negotiated directly between two parties, rather than being traded on a public exchange. This customization allows for flexibility in terms such as notional principal, maturity date, and payment frequency. However, it also means that ISDRs carry counterparty risk, the risk that the other party to the contract will default on their obligations. Regulatory reforms have sought to mitigate this risk, for instance, by encouraging or mandating the clearing of standardized swaps through central clearinghouses.