Exposure - CSA Provision

2016 VM CSA Anatomy™ →Go uptown In a Nutshell™ Section Exposure: A party’s “Exposure” means the amount it would pay (a positive Exposure) or receive (a negative Exposure) if all Covered Transactions other than this Credit Support Annex were terminated as at the Valuation Time following a Termination Event where the other party was the One Affected Party, the Base Currency was the Termination Currency and the Valuation Agent made the valuations on the party’s behalf using mid-market estimates of the amounts that would be required under the ISDA Master Agreement. view template 2016 VM CSA full text of Section Exposure: “Exposure” means, unless otherwise specified in Paragraph 11 for any Valuation Date or other date for which Exposure is calculated and subject to Paragraph 4 in the case of a dispute: (i) if this Agreement is a 1992 ISDA Master Agreement, the amount, if any, that would be payable to that party by the other party (expressed as a positive number) or by that party to the other party (expressed as a negative number) pursuant to Section 6(e)(ii)(1) of this Agreement if all Covered Transactions (other than the Transaction constituted by this Annex) were being terminated as of the relevant Valuation Time on the basis that (A) that party is not the Affected Party and (B) the Base Currency is the Termination Currency; provided that Market Quotations will be determined by the Valuation Agent on behalf of that party using its estimates at mid-market of the amounts that would be paid for Replacement Transactions (as that term is defined in the definition of “Market Quotation”); and (ii) if this Agreement is an ISDA 2002 Master Agreement or a 1992 ISDA Master Agreement in which the definition of Loss and/or Market Quotation has been amended (including where such amendment has occurred pursuant to the terms of a separate agreement or protocol) to reflect the definition of Close-out Amount from the pre-printed form of the ISDA 2002 Master Agreement as published by ISDA, the amount, if any, that would be payable to that party by the other party (expressed as a positive number) or by that party to the other party (expressed as a negative number) pursuant to Section 6(e)(ii)(1) (but without reference to clause (3) of Section 6(e)(ii)) of this Agreement as if all Covered Transactions (other than the Transactions constituted by this Annex) were being terminated as of the relevant Valuation Time on the basis that (A) that party is not the Affected Party and (B) the Base Currency is the Termination Currency; provided that the Close-out Amount will be determined by the Valuation Agent on behalf of that party using its estimates at mid-market of the amounts that would be paid for transactions providing the economic equivalent of (X) the material terms of the Covered Transactions, including the payments and deliveries by the parties under Section 2(a)(i) in respect of the Covered Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date (assuming satisfaction of the conditions precedent in Section 2(a)(iii) of this Agreement); and (Y) the option rights of the parties in respect of the Covered Transactions. view template Related Agreements Click here for the text of Section Exposure in the 1995 English Law CSA Click here for the text of Section Exposure in the 2016 English Law VM CSA Click [[{{{3}}} - NY VM CSA Provision|here]] for the text of the equivalent, Section [[{{{3}}} - NY VM CSA Provision|{{{3}}}]] in the 2016 NY Law VM CSA Comparisons 1995 CSA and 2016 VM CSA: click for comparison {{nycsadiff {{{3}}}}} Resources Full wikitext | Nutshell wikitext Navigation 1 (Interpretation) | 2 (Credit Support Obligations) | 3 (Transfers, Calculations and Exchanges) | 4 (Dispute Resolution) | 5 (Title Transfer etc) | 6 (Default) | 7 (Representation) | 8 (Expenses) | 9 (Miscellaneous) | 10 (Definitions) | 11 (Elections and Variables) Index: Click ᐅ to expand: 2016 VM CSA 2018 CSD 1995 CSA Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

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 1995 CSA itself, because that would entirely bugger things up: the MTM of an ISDA including the CSA is, of course, more or less zero.

Discussion

• 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.
• 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...

Relevance of Section 6 to the peacetime operation of the Credit Support Annex

The calculation of {{{{{1}}}|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 {{{{{1}}}|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 “{{{{{1}}}|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 {{{{{1}}}|Delivery Amount}} or {{{{{1}}}|Return Amount}}, as the case may be, is just the difference between that Exposure and whatever the existing {{{{{1}}}|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 {{{{{1}}}|Exposure}} — is out of the money — to the tune of 100. Its prevailing {{{{{1}}}|Credit Support Balance}} is 90, so (let’s say, for fun, after the {{{{{1}}}|Notification Time}} on the {{{{{1}}}|Demand Date}}) Party B has called it for a {{{{{1}}}|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 {{{{{1}}}|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 {{{{{1}}}|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.

Calculating your {{{{{1}}}|Credit Support Amount}}

Superficially things are quite different between the 1995 CSA and the 2016 VM CSA, but this all boils down to the fact that the 2016 VM CSA is meant to be a zero-threshold, variation margin-only affair, so the concepts of Independent Amount and Threshold, both of which confuse the 1995 CSA, aren’t there to get in the way. Unless you go and put them in anyway, as we shall see...

1995 CSA

How the IA contributes to the Credit Support Amount — being the amount of credit support in total that one party must have given the other at any time under the 1995 CSA can be mind-boggling.

It pans out for a Transferee like so:

• The Transferee’s Exposure: the net mark-to-market value the Transferor would owe the Transferee under all outstanding Transactions if they were closed out (not counting, of course, the 1995 CSA itself). Call this E_Tee.
• The Transferor’s Independent Amount: The total Independent Amount Transferor must give the Transferee we will call IA_Tor. You can add this to the Transferee’s Exposure, but then you must remember to deduct ...
• The Transferee’s Independent Amount: Any Independent Amount the Transferee has to pay the Transferor. Call this IA_Tee. . Lastly don’t forget to take into account ...
• The Transferor’s Threshold: Any Threshold that applies to the Transferor being the Exposure it is allowed to represent before it has to post variation margin in the first place.
  

This leaves you with a formula for a Transferee’s Credit Support Amount as follows: Max[0, (E_Tee + IA_Tor - IA_Tee + Threshold)].

Let’s plug in some numbers. Say:

• The Transferee’s Exposure is 10,000,000
• The Transferor’s Independent Amount IA_Tor is 2,000,000
• The Transferee’s Independent Amount IA_Tee is 0
• The Transferor’s Threshold is 5,000,000

Your Credit Support Amount is therefore the greater of zero and 10,000,000 + 2,000,000 - 0 + 5,000,000) = 7,000,000.

Now, whether you have to pay anything or receive anything as a result — whether there is a Delivery Amount or a Return Amount, in other words — depends whether your Credit Support Amount is greater or smaller than your prevailing Credit Support Balance, by at least the Minimum Transfer Amount.

2016 VM CSA with no IA amendment

Since the 2016 VM CSA assumes there is no Independent Amounts and no Thresholds, it is quite a lot easier. It is just the Exposure. So much so, that there isn’t even a concept of the “Credit Support Amount” under the 2016 VM CSA, unless you have retrofitted one, and who in their right mind would do that?

Oh.

You have, haven’t you. You’ve gone and co-opted the Credit Support Amount (VM/IA) concept in your Paragraph 11 elections. Yes you did. No, don’t blame your credit department; don’t say you were just following orders. You did it.

2016 VM CSA with a customised IA amendment

Never mind. Well, just for you, the formula is a sort of half-way house: Under this unholy bastardisation of a 2016 VM CSA, a Transferee’s Credit Support Amount will be: Max[0, (E_Tee + IA_Tor - IA_Tee)].

Transaction flows and collateral flows

In a fully margined ISDA Master Agreement, all other things being equal, the termination of a Transaction will lead to two equal and opposite effects:

• A final payment or exchange under the Transaction having a value more or less equal to the present value of that Transaction;
• A offsetting change in the Exposure under the CSA in exactly the same value.

The strict sequence of these payments ought to be that the Transaction termination payment goes first, and the collateral return follows, since it can only really be calculated and called once the termination payment has been made.

I know what you’re thinking. Hang on! that means the termination payer pays knowing this will increase its Exposure for the couple of days it will take for that collateral return to find its way back. That’s stupid!

What with the regulators’ obsession minimise systemic counterparty credit risk, wouldn’t it be better to apply some kind of settlement netting in anticipation, to keep the credit exposure down?

Now, dear reader, have you learned nothing? It might be better, but “better” is not how ISDA documentation rolls. The theory of the ISDA and CSA settlement flows puts the Transaction payment egg before the variation margin chicken so, at the moment, Transaction flows and collateral flows tend to be handled by different operations teams, and their systems don’t talk. Currently, the payer of a terminating transaction has its heart in its mouth for a day or so.

Industry efforts to date have been targeting at shortening the period between the Exposure calculation and the final payment of the collateral transfer.