DISCLOSURE OF PRINCIPAL RISK FACTORS IN SWAPS
PRINCIPAL RISK FACTORS IN SWAPS TRANSACTIONS IN OVER-THE-COUNTER DERIVATIVES OR SWAPS HAVE SIGNIFICANT RISKS, INCLUDING, BUT NOT LIMITED TO, SUBSTANTIAL RISK OF LOSS. THIS STATEMENT OF GENERIC RISKS ASSOCIATED WITH SWAP TRANSACTIONS IS INTENDED TO IDENTIFY, IN GENERAL TERMS, CERTAIN OF THE PRINCIPAL RISKS ASSOCIATED WITH INDIVIDUALLY NEGOTIATED SWAP TRANSACTIONS. IT DOES NOT PURPORT TO IDENTIFY THE NATURE OF THE SPECIFIC MARKET OR OTHER RISKS ASSOCIATED WITH A PARTICULAR TRANSACTION.
Before entering into a swap transaction, you should ensure that you fully understand the terms of the transaction, relevant risk factors, the nature and extent of your risk of loss and the nature of the contractual relationship into which you are entering. You should also carefully evaluate whether the transaction is appropriate for you in light of your experience, objectives, financial resources, and other relevant circumstances and whether you have the operational resources in place to monitor the associated risks and contractual obligations over the term of the transaction.
The Advisor provides hedge advisory and execution advice. Although the Advisor may assist in the preparation and negotiation of the legal, tax and regulatory aspects of the arrangement of a swap transaction, it is not qualified to provide legal or tax advice in this or any area. If you believe you need legal or tax assistance in evaluating and understanding the terms or risks of a particular swap transaction, you should consult appropriate advisers before entering into the transaction.
Swap transactions, like other financial transactions, involve a variety of significant risks. The specific risks presented by a particular swap transaction necessarily depend upon the terms of the transaction and your circumstances. In general, however, all swap transactions involve some combination of market risk, credit risk, funding risk, operational risk, foreign currency risk, and legal risk.
Market risk is the risk that the value of a swap transaction will be adversely affected by fluctuations in the level or volatility of or correlation or relationship between one or more market prices, rates or indices or other market factors, or by illiquidity in the market for the relevant transaction or in a related market (which could cause you to be unable to sell or terminate the swap transaction for a period of time, or could cause you to be unable to sell or terminate the swap transaction at a previously quoted price). Credit risk is the risk that a counterparty will fail to perform its obligations to you when due.
Credit risk is also the risk that, upon such failure by a counterparty, you may experience delays in collecting, or be unable to collect, collateral or margin you have previously posted.
Funding risk is the risk that, as a result of mismatches in the economic terms of a swap, including, without limitation, delays in the timing of cash flows due from or to your counterparties in swap transactions or related hedging, trading, collateral or other transactions, you or your counterparty will not have adequate cash available to fund current obligations.
Operational risk is the risk of loss to you arising from inadequacies in or failures of your internal systems and controls for monitoring and quantifying the risks and contractual obligations associated with swap 12 transactions, for recording and valuing swaps and related transactions, or for detecting human error, systems failure or management failure.
Foreign Currency Risk is the risk of the amount of capital exposed to fluctuations in the value of a foreign currency. Trading on foreign exchanges may present greater risks as foreign exchanges are not regulated by the CFTC or any other United States governmental agency. Trading on foreign exchanges may be subject to regulations that are different from those to which United States exchange trading is subject, may provide less protection to investors than trading on United States exchanges and may be less vigorously enforced than regulations in the United States. In addition, positions on foreign exchanges are subject to the risk of exchange controls, expropriation, excessive taxation and government disruptions. Losses could also occur when determining the value of foreign positions in U.S. dollars because of fluctuations in exchange rates.
Legal Risk is the risk that transactions and netting arrangements entered into may not meet legal requirements.
Individually Negotiated Contracts: Because the price and other terms on which you may enter into or terminate a swap transaction are individually negotiated, these may not represent the best price or terms available to you from other sources.
Modification or Termination: In evaluating the risks and contractual obligations associated with a particular swap transaction, you should also consider that a swap transaction may be modified or terminated only by mutual consent of the original parties and subject to agreement on individually negotiated terms. Accordingly, it may not be possible for you to modify, terminate or offset your obligations or your exposure to the risks associated with a transaction prior to its scheduled termination date.
Indicative or Mid-Market Quotations: While market makers and dealers generally quote prices or terms for entering into or terminating swap transactions and provide indicative or mid-market quotations with respect to outstanding swap transactions, they may not be required to do so under applicable laws and regulations and are generally not contractually obligated to do so or to continue to do so once a line of credit has been established for you with that market maker or dealer. In addition, it may not be possible to obtain indicative or mid-market quotations for a swap transaction from a market maker or dealer that is not a counterparty to the transaction. Consequently, it may be difficult for you to establish an independent value for an outstanding swap transaction. You should not regard your counterparty’s provision of a valuation or indicative price at your request as an offer to enter into or terminate the relevant transaction at that value or price, unless the value or price is identified by the counterparty as firm or binding. Additionally, any valuation or indicative price estimate
that the Advisor may provide is solely a good faith mid-market estimate and you should be aware that provision of a valuation or price estimate by the Advisor does not provide any assurance that you will be able to execute, cash-settle or terminate your desired swap at such price, since actual pricing offered in the swaps marketplace can be affected by many factors not considered in calculating a mid-market valuation or indicative pricing estimate.
Speculative and Volatile: Although the Advisor generally provides advice for hedging purposes, a portion of many trades may not correlate perfectly with the underlying risk being hedged, leading to additional risk of loss similar to speculative trades. A decision to enter into a trade that only partially hedges an underlying position may not be distinguishable economically from a speculative trade. Prices quoted in the OTC markets may be highly volatile (i.e. prices either increase or decrease rapidly based upon various market or global occurrences). The Advisor cannot provide assurance that its advice will result in a perfect hedge or a profitable result in the case of trades that only partially hedge underlying positions.
OTC Trading May Be Illiquid: The OTC markets may pose a risk that a particular quote may not be provided by any bank or FCM which could pose substantial risk if a client was unable to close out a position.
Speculative Nature of OTC Trading: Swaps, unlike many securities, do not pay any dividends. Profits can be made by (i) selling a contract at a higher price than that at which it was bought, (ii) by buying a contract at a lower price than that at which it was sold or (iii) or receiving payments on a swap that are in excess of the amounts paid for the original position.
OTC Spot, Forward and Options Trading Is Not Protected By Exchange Or Clearinghouse Guarantees Or Government Regulation: The Advisor will trade forward contracts. In addition, the Advisor may trade cash or “spot” contracts in connection with EFPs, among other situations, and possibly over-the-counter options as well (together with over-the-counter spot and forward contracts, “OTC contracts”). Unlike futures contracts, the performance of OTC contracts is not guaranteed by any exchange or clearinghouse. Because there is no exchange or clearinghouse guarantee, OTC contracts may result in substantial losses if the counterparty to such transactions is unable to perform. Counterparties in the OTC spot, forward, and options markets have no obligation to continue to make markets in the OTC contracts. There have been periods during which certain dealers have refused to quote prices for OTC contracts or have quoted prices with an unusually widespread between the price at which they are prepared to buy and that at which they are prepared to sell. Illiquidity and, at times, a lack of price transparency in one or more OTC markets may affect trades to the detriment of the Advisor’s clients.
Diversification: The Advisor’s services are limited to swaps. The advice and trade recommendations are not diversified amongst asset classes such as stocks, bonds, real estate, etc. In addition, the Advisor’s trading advice is not diversified amongst the various commodity interests. There may be other significant risks that should be considered based on the terms of a specific transaction. Highly customized swaps in particular may increase liquidity risk and introduce other significant risk factors of a complex character. Highly leveraged transactions may experience substantial gains or losses in value as a result of relatively small changes in the value or level of an underlying or related market factor. This brief statement does not purport to disclose all of the risks and other material considerations associated with a swap transaction. You should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss.