Exposure - CSA Provision
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1995 ISDA Credit Support Annex (English Law)
Paragraph Exposure in a Nutshell™ Use at your own risk, campers!
Full text of Paragraph Exposure
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Content and comparisons
Summary
The total mark-to-market exposure under your ISDA Master Agreement on a given day, not counting anything posted by way of credit support. That is, Exposure omits the mark-to-market exposure of the Transaction comprising the CSA itself,[1] because that would entirely bugger things up: the MTM of an ISDA including the CSA is, of course, more or less zero.
Relevance of Section 6 to the peacetime operation of the Credit Support Annex
The calculation of Exposure under the CSA is modelled on the Section 6(e)(ii) termination methodology following a Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.
This means you calculate the Exposure as:
- (a) the Close-out Amounts for each Terminated Transaction plus
- (b) Unpaid Amounts due to the Non-defaulting Party; minus
- (c) Unpaid Amounts due to the Defaulting Party.
There aren’t really likely, in peacetime, to be Unpaid Amounts loafing about — an amount that you are due to pay today or tomorrow wouldn’t, yet, qualify as “unpaid”, but would be factored into the Close-out Amount calculation.
There is a little bit of a dissonance here, since “Exposure” is a snapshot calculation that treats all future cashflows, whether due in a day, a month or a year from today, the same way: it discounts them back to today, adds them up and sets them off. Your Delivery Amount or Return Amount, as the case may be, is just the difference between that Exposure and whatever the existing Credit Support Balance is. The future is the future: unknowable, unpredictable, but discountable, whether it happens in a day or a thousand years.
All the same, this can seem kind of weird when your CSA you have to pay him an amount today when he owes you an even bigger amount tomorrow. It’s like, “hang on: why am I paying you margin when, tomorrow, you are going to be in the hole to me? Like, by double, if I pay you this margin and you fail to me tomorrow.”
The thing which, I think, causes all the confusion is the dates and amounts of payments under normal Transactions are deterministic, anticipatable, and specified in the Confirmation, whereas whether one is required under a CSA on any day, and how much it will be, depend on things you only usually find out about at the last minute. CSA payments are due “a regular settlement cycle after they are called” — loosey goosey, right? — (or even same day if you are under a VMV CSA and you are on the ball with your calls) whereas normal swap payments are due (say) “on the 15th of March”
So, a scenario to illustrate:
- Day 1: Party A has an Exposure — is out of the money — to the tune of 100. Its prevailing Credit Support Balance is 90, so (let’s say, for fun, after the Notification Time on the Demand Date) Party B has called it for a Delivery Amount of a further 10, which it must pay, but not until tomorrow.
- Day 2: Meanwhile, Party A has a Transaction payment of 10 that falls due to Party B, also tomorrow. The arrival of this payment will change Party A’s Exposure to Party B so it is 90. Assuming Party A also pays the Delivery Amount, by knock-off time tomorrow it will have posted a Credit Support Balance of 100, and its Exposure to Party B will only be 90. This means it will be entitled to call Party B for a Return Amount of 10.
This seems rather a waste of operational effort, and will also take years off your credit officer’s life and may even cause his hair to catch fire. Can Party A just not pay the further Delivery Acount in anticipation of what will happen tomorrow?
Fun times in the world of collateral operations.
Market Quotation and the 2002 ISDA
- Market Quotation? But I have a 2002 ISDA: Note the references to Market Quotation and other 1992 ISDA specific things. If you are under a 2002 ISDA, these should be corrected. Of you could sign up to the 2002 ISDA Master Agreement Protocol and that would do it for you. In the 2016 VM CSA, note both versions of the ISDA Master Agreement, with their contrasting approaches to close-out valuation, are provided for in the alternative.
- Mid-market?: A slight cognitive dissonance: It talks about your 6(e)(ii) amount - which is generally your replacement cost, at your side of the market, but then goes on to say determined at the mid-market price, which is fair, though, because you aren’t in default, and if each party used its own side of the market the Credit Support Balance could never find stability or happeness, even fleetingly, and the credit support world would be in some kinds of infinite loop.
General discussion
See also
Template:M sa 1995 CSA Exposure
References
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ISDA 1994 New York Law Credit Support Annex
A Jolly Contrarian owner’s manual™ Exposure in a Nutshell™ Original text:
Resources and Navigation
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Overview
Ancient v Modern
The difference between the Ancient and Modern versions of the CSA is that the OG CSAs assume you are trading under a 1992 ISDA, therefore using the Market Quotation valuation technique — which figures, since the 2002 ISDA with its Close-out Amount methodology hadn’t then been invented — whereas the Modern CSAs contemplate you having a either a 1992 ISDA or a 2002 ISDA and provides for them in the alternative.
Here is a comparison between the 1995 CSA and the 2016 VM CSA
NY v English law
The 2016 NY Law VM CSA tracks the 2016 VM CSA closely with two curious exceptions: Firstly, when imagining its hypothetical termination of all Transactions it doesn’t explicitly carve out the Transaction constituted by the 2016 NY Law VM CSA itself — which is odd, because if you were treating it as a Transaction to be hypothetically included, you necessarily get a value of zero, since its value should be the exact negative of whatever the net mark-to-market value of all the other Transactions are — and secondly it does not hypothetically suppose that the Secured Party is the Unaffected Party, thereby getting to be in the driver’s seat when constructing the necessary valuations.
The reason you don’t have to except a 2016 NY Law VM CSA from hypothetical termination is buried deep in its earthen ontological root system. It is not a Transaction. This is all discussed in the Preamble.
Summary
The total mark-to-market exposure under your ISDA Master Agreement on a given day, not counting anything posted by way of credit support. That is, Exposure omits the mark-to-market exposure of the Transaction comprising the CSA itself,[2] because that would entirely bugger things up: the MTM of an ISDA including the CSA is, of course, more or less zero.
Relevance of Section 6 to the peacetime operation of the Credit Support Annex
The calculation of Exposure under the CSA is modelled on the Section 6(e)(ii) termination methodology following a Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.
This means you calculate the Exposure as:
- The Close-out Amounts for each Terminated Transaction plus
- Unpaid Amounts due to the Non-defaulting Party; minus
- Unpaid Amounts due to the Defaulting Party.
There aren’t really likely, in peacetime, to be Unpaid Amounts loafing about — an amount that you are due to pay today or tomorrow wouldn’t, yet, qualify as “unpaid”, but would be factored into the Close-out Amount calculation.
There is a little bit of dissonance here, since “Exposure” is a snapshot calculation that treats all future cashflows, whether due in a day, a month or a year from today, the same way: it discounts them back to today, adds them up and sets them off. Your Delivery Amount or Return Amount, as the case may be, is just the difference between that Exposure and whatever the existing Credit Support Balance is. The future is the future: unknowable, unpredictable, but discountable, whether it happens in a day or a thousand years.
All the same, this can seem kind of weird when your CSA you have to pay him an amount today when he owes you an even bigger amount tomorrow. It’s like, “hang on: why am I paying you margin when, tomorrow, you are going to be in the hole to me? Like, by double, if I pay you this margin and you fail to me tomorrow.”
The thing which, I think, causes all the confusion is the dates and amounts of payments under normal Transactions are deterministic, anticipatable, and specified in the Confirmation, whereas whether one is required under a CSA on any day, and how much it will be, depend on things you only usually find out about at the last minute. CSA payments are due “a regular settlement cycle after they are called” — loosey goosey, right? — (or even same day if you are under a VMV CSA and you are on the ball with your calls) whereas normal swap payments are due (say) “on the 15th of March”
So, a scenario to illustrate:
Day 1: Party A has an Exposure — is out of the money — to the tune of 100. Its prevailing Credit Support Balance is 90, so (let’s say, for fun, after the Notification Time on the Demand Date) Party B has called it for a Delivery Amount of a further 10, which it must pay, but not until tomorrow.
Day 2: Meanwhile, Party A has a Transaction payment of 10 that falls due to Party B, also tomorrow. The arrival of this payment will change Party A’s Exposure to Party B so it is 90. Assuming Party A also pays the Delivery Amount, by knock-off time tomorrow it will have posted a Credit Support Balance of 100, and its Exposure to Party B will only be 90. This means it will be entitled to call Party B for a Return Amount of 10.
This seems rather a waste of operational effort, and will also take years off your credit officer’s life and may even cause his hair to catch fire. Can Party A just not pay the further Delivery Acount in anticipation of what will happen tomorrow?
Fun times in the world of collateral operations.
“Market Quotation” where you have a 2002 Master
Note the references to Market Quotation and other 1992 ISDA specific things on the OG CSAs.
If you are under a 2002 ISDA but an OG CSA, these need to be corrected. Of you could sign up to the 2002 ISDA Master Agreement Protocol and that would do it for you.
The Modern CSAs accommodate all extant versions of the ISDA Master Agreement, with their contrasting approaches to close-out valuation, in the alternative. Which is nice.
“Mid-market”?
A slight cognitive dissonance: It talks about your 6(e)(ii) amount - which is generally your replacement cost, at your side of the market, but then goes on to say determined at the mid-market price, which is fair, though, because you aren’t in default, and if each party used its own side of the market the Credit Support Balance could never find stability or happiness, even fleetingly, and the credit support world would be in some kinds of infinite loop.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays
See also
References
- ↑ Assuming you are on a proper, sensible, English law title transfer CSA, which counts as a Transaction, and not one of those silly American ones, which doesn’t.
- ↑ Assuming you are on a proper, sensible, English law title transfer CSA, which counts as a Transaction, and not one of those silly American ones, which doesn’t.