Template:Csa Transfer of Title summ

Clearing system liens

In these modern, dematerialised but not yet entirely decentralised times, the securities in a clearing system — that is, pretty much all securities — exist only as entries in a ledger maintained by the clearing system. The individual securities are no longer and have not been for a half-century or more, security-printed, physical things. It may be we are moving “on-chain” but it has not happened yet, and if the speed at which lawyers have given up the legal vestiges of definitive physical securities is anything to go by, it will not happen for some time yet. Sorry, hodlers: I don’t make the rules. ANYWAY.

In any case, like all good intermediaries, the clearing system gets fees from participants for being a clearing system. As a kind of surety against non-payment of these fees, it keeps a lien on all global securities it holds. All this means is, if you haven’t paid your fees, you can’t have your securities back — conceptually a weird prospect, since you can’t have your securities back, can you — there are no physical securities — but in practice, you can’t deal with them without paying your fees, and even more realistic practice, if you do, the clearing systems will just deduct their fees from your sale proceeds. all of this is entirely unobjectionable, entirely normal, should not ever offend or adversely affect anyone, but it is, by the lights of the law, a “security interest” and therefore is regarded as a necessary exception, to be mentioned for the avoidance of doubt and carved out in polite circles whenever one makes sweeping statements as to the lack of any encumbrances on one’s assets.

Now all this sits a long way down the stack of turtles that makes up the modern metaphysical financial system — almost so deep as to be beyond the paranoid articulations of an ISDA ninja — but, as you can see, not quite.

The twain between NY law and English law CSAs: pledge v title transfer

This feels as good a time as any to raise the great subject of title transfer and pledge.

Under a 1994 NY CSA one transfers {{{{{1}}}|Credit Support}} by means of pledge.

Under a English law CSA one transfers {{{{{1}}}|Credit Support}} by title transfer.

What is the difference?

Title transfer

Under a “title transfer collateral arrangement” one party transfers collateral to the other outright and absolutely: it gives it, free of all reversionary interests, to the {{{{{1}}}|Transferee}}.

Securities delivered to {{{{{1}}}|Transferee}} become the {{{{{1}}}|Transferee}}’s property absolutely. There is no custody involved: the {{{{{1}}}|Transferee}} owns them outright, and not to {{{{{1}}}|Transferor}}’s order. The {{{{{1}}}|Transferee}} has only an obligation to redeliver an “equivalent” security — ie one that is fungible with the {{{{{1}}}|Credit Support}} originally posted.

There are no custody/client asset regulatory issues, and nor does it make sense to talk about the {{{{{1}}}|Transferee}}’s right to “reuse” or “rehypothecate” the asset. It owns the asset outright: by definition, it can do what it wants with it.

Pledge

The NY law CSAs and English law CSDs are “security financial collateral arrangements” in that there is a {{{{{1}}}|Pledgor}} who creates a security interest in favour of the {{{{{1}}}|Secured Party}}, but retains beneficial ownership of the assets.

The {{{{{1}}}|Pledgor}} delivers the assets to the {{{{{1}}}|Secured Party}} to hold in custody, subject to the security interest, for the {{{{{1}}}|Pledgor}}. {{{{{1}}}|Secured Party}} holds the assets subject to a security interest securing its payment obligation under the related transaction.

There is a custody arrangement but only while {{{{{1}}}|Secured Party}} holds the security: Under the NY law CSAs, the {{{{{1}}}|Secured Party}} (by default) is entitled to sell the pledged asset absolutely, under a process known as “rehypothecation”. This, we believe, converts the security financial collateral arrangement into a title transfer collateral arrangement — at least from the point of rehypothecation. If so, it makes you wonder why, you know, all the fuss with security interests.

“Transaction” or “Credit Support Document”?

English law Credit Support Annexes are Transactions under the Master Agreement. Therefore they are not Credit Support Documents.

New York law Credit Support Annexes are not Transactions. Explicitly, they are Credit Support Documents, though you should not (according to the ISDA User’s Guide) describe the parties to one as “Credit Support Providers”.

English law Credit Support Deeds (including the 2018 English law IM CSD) — rare birds in the Forest of Bretton — are not Transactions and, explicitly, are Credit Support Documents.

This means that a failure to perform under an English law CSA Transaction is a Failure to Pay or Deliver under Section 5(a)(i). by contrast, a failure to perform under a New York law CSA or an English law CSD is a Credit Support Default under Section 5(a)(iii).

Does this mean anything substantive? Or is the difference only formal?

Enforcement

Because ownership transfers absolutely, a {{{{{1}}}|Transferee}} under an English law CSA doesn’t have to do anything to enforce its collateral. It already owns it outright. Indeed, to the contrary, should the {{{{{1}}}|Exposure}} that the collateral supports disappear, the {{{{{1}}}|Transferor}} will be the creditor of the {{{{{1}}}|Transferee}}. It is as if it were a Transaction under the ISDA where the mark-to-market exposure had flipped around.

As New York law CSAs are not Transactions, they are old-fashioned security arrangements. Therefore they 'are Credit Support Documents in the labyrinthine logic of ISDA’s crack drafting squad™ and must be enforced.

Distributions and Interest Amount

It used to be so simple, until the 2016 VM CSA came along and started confusing everything with all this talk of Interest Adjustments versus Interest Payments.

This part simply requires the holder of credit support to manufacture income back to the poster of credit support — as long as doing so wouldn’t create in itself trigger a further Delivery Amount by the Transferor — thus precipitating a (short) game of operational ping-pong between the two parties’ back office teams.

How would that happen? All other things staying equal, it couldn’t: if the Transferee’s Exposure and the Value of the Transferor’s Credit Support Balance stayed the same as it was when variation margin was last called, the arrival of income on any part of that Credit Support Balance ought to be spirited back to the Transferor: as long as the Transferee was still holding it, the Transferee otherwise would become indebted for the value of that income to the Transferor.

But as we know, Exposures don’t just quietly sit there. If they did, there wouldn’t be any need for initial margin, and collecting even variation margin would be less fraught. So if the Transferee’s Exposure has increased, the arrival of that income might serve to fill a hole in the existing coverage, in which case, why pay it away only to ask for it back again? Similarly, the value of a pending but as-yet-unpaid income payment will be priced into the value of the securities generating it. So even if the Exposure hasn’t changed in the mean time, the arrival of a coupon or dividend will reduce the Value of those securities on which it was paid, so — all other things being equal — the Transferee might expect to hang onto the Distribution.
To be fair to them, the OG only contemplated transfer of accrued interest, which in the context of a modern, daily margined swap business, is barking mad, so at least having the option to just capitalise interest is better than not having it.

But better still would be just straight out capitalising interest, with no option to transfer it. Perhaps this is just me.

Interest Amounts under the 1995 CSA

It really ought to be quite simple, and in the 1995 CSA it is: if a {{{{{1}}}|Transferor}} has posted cash — probably less likely back in the day, but in the world of regulatory margin, de rigueur nowadays — then you get interest on it — as long as paying interest wouldn’t, in itself, trigger a call for a further {{{{{1}}}|Delivery Amount}} by the {{{{{1}}}|Transferor}} — thus precipitating a (short) game of operational ping-pong between the two parties’ back office teams.

How would that happen? All other things staying equal, it couldn’t: if the {{{{{1}}}|Transferee}}’s {{{{{1}}}|Exposure}} and the {{{{{1}}}|Value}} of the {{{{{1}}}|Transferor}}’s {{{{{1}}}|Credit Support Balance}} stayed the same as it was when variation margin was last called, the arrival of interest on any part of that {{{{{1}}}|Credit Support Balance}} increases its value and, since it was calibrated to equal an exposure exactly, ought to be spirited back to the {{{{{1}}}|Transferor}}: the {{{{{1}}}|Transferee}} otherwise would become indebted for the value of that interest to the {{{{{1}}}|Transferor}}, which for variation margin is not the idea.

But as we know, {{{{{1}}}|Exposure}}s don’t just quietly sit there. If they did, there wouldn’t be any need for initial margin, and collecting even variation margin would be less fraught. So if the {{{{{1}}}|Transferee}}’s {{{{{1}}}|Exposure}} has increased, the arrival of that interest might serve to fill a hole in the existing coverage, in which case, why pay it away only to ask for it back again?

Interest Amounts under the 2016 VM CSA

But in the 2016 VM CSA things get a little more complex. There follows an excruciating torture session for innocent and well-loved members of Her Majesty’s vocabulary, and all to get across a simple point. In the premium content nutshell JC has tried to simplify the drafting but I am a bit jet-lagged and it is testing even my patience. But know this: {{{{{1}}}|Interest Payment}} is a fiddly, time-and resource-consuming pain which will inevitably lead to error, confusion and name-calling. {{{{{1}}}|Interest Adjustment}} — just adding accrued interest to your {{{{{1}}}|Credit Support Balance}} — is far simpler and more elegant: none of this Kafkaesque complexity for netting and offsetting individual payments. It all comes out in the wash.

When you might want Interest Payment

Now there is a “use-case” for the Interest Payment method — it’s pretty niche, though — which we will talk about over at the premium JC.