Template:Csa Credit Support Obligations summ

The overall vibe of a Credit Support Annex is self-help.

It is presumed on any day there will be a portfolio of Transactions outstanding under the ISDA (not counting the CSA itself, which under the English law construct, is also a “Transaction”, though it is not under a NY law construct), and these Transactions will each create a market exposure, and when those market exposures are summed, will create an overall “{{{{{1}}}|Exposure}}” owed by one party or the other.

The party to whom the netted amount would be paid were the ISDA Master Agreement closed out on that day can — subject to a few conditions — call for {{{{{1}}}|Eligible Credit Support}} from the party who would be due to pay it.

“Valuation Agent”

Just why one needs to call the person making a demand for Credit Support under a CSA a Valuation Agent, and not — well, the Party making the demand — seeing as that person is acting for themselves is not in any sense anyone’s agent (no, you can’t be your own agent, however much legal eagles would like that to be so. The principle — which I just made up but based off a real Latinism, is nemo agens in causa sua.)

The starting proposition, which hasn’t really changed since the salad days of the First Men at the dawn of the Age of Swaps, is that if you are a big enough boy to trade derivatives, you are big enough — short hand for “have a treasury function of some kind competent enough” — to calculate your own margin requirements. This largely remains the case, though there are a few categories of financial services fauna who are not: Repackaging vehicles, for one, and investment funds who have outsourced their asset management to an investment adviser for another — and those margin borrowers and hedgies with prime brokerage relationships may find them being obliged to hand over the margin function, all for fairly sensible reasons.

And show me the legal eagle who doesn’t like a multi-level waterfall replacement Valuation Agents, reference dealers, law society presidents, professional arbitrators and other fallback waifs and strays should the parties not enjoy their agents’ valuations, should they not be forthcoming in a timely way etc.

Title transfer versus pledge

English law CSAs are title transfer CSAs. {{{{{1}}}|Credit Support}} is delivered outright against a contingent obligation on the Transferee to return “equivalent” — meaning fungible — {{{{{1}}}|Credit Support}}. As such, the {{{{{1}}}|Transferor}} has no legal or beneficial interest in {{{{{1}}}|Credit Support}} it has posted: it has only a debt claim against the {{{{{1}}}|Transferee}} for its return (which would be netted off against the {{{{{1}}}|Transferee}}’s debt claim against it under the ISDA Master Agreement). This is why an English law CSA is treated as a {{{{{1}}}|Transaction}}: it is, in every sense, identical to a physically settled asset swap.

New York law CSAs are security interest CSAs: {{{{{1}}}|Credit Support}} is posted by way of security, and the {{{{{1}}}|Transferee}} takes only legal title, holding beneficial interest in the {{{{{1}}}|Credit Support}} for the Transferor. This markedly changes the netting analysis. But — unless the option has been disapplied in the elections paragraph, the holder of pledged Credit Support is entitled to “rehypothecate” it — transfer it outright to a third party, against an obligation to return a fungible asset — and while U.S. attorneys may beg to differ this, to a jaundiced English lawyer, makes a NY law CSA materially identical to an English law one. Both are effectively, title transfer arrangements.

English law Credit Support Deeds, such as the 2018 English law IM CSD, are security interest CSAs. They do not generally allow reuse: for the Ancient version, it wouldn’t make any sense to take under a pledge/custody model, mark yourself in scope for CASS and all that carry on, and then deliver away the collateral: if you wanted to do that it would be better tpo just use a normal title transfer CSA. As a result the 1995 ISDA Credit Support Deed is seldom spoken of, an even more seldom seen. The 2018 English law IM CSD, being a regulatory IM document, specifically forbids reuse of collateral. The whole point of reg IM is that someone sensible is meant to sit on it at all times.

Credit Support Balance v Posted Credit Support

Quick terminology check: “{{{{{1}}}|Eligible Credit Support}}”, once delivered to the person demanding it under a title transfer CSA is called the “Credit Support Balance” and under a security interest CSA is called “Posted Credit Support”. This seems annoying, and is, but ISDA’s crack drafting squad™ has its reasons, as ever. The difference reflects their differing ontological statuses. True.

Collateral posted under a title transfer CSA goes outright, leaving the deliveror only a simple debt claim for an equivalent asset. There is no sense of custody; no bailment; no lingering interest in what has been sent away. It is not like it has been posted into a cubby-hole to be kept safe and sound and later returned. Hence, it is just a “Credit Support Balance”.

Collateral posted under a security interest CSA is “posted” on that basis; there is a (conditioned) expectation of getting back the same thing you sent. This expectation is annihilated by the act of rehypothecation, but still, in theory, it is for an instant there. Hence what you have is “Posted Credit Support”.

However compelling the intellectual grounds for the distinction, in practice it is annoying, especially if you happen to be speaking generally about ISDA Credit Support Annexes of either kind, as the JC is. For ease of deference to his usual slapdash way of thinking about things JC will refer to either as simply “{{{{{1}}}|Credit Support}}”. that can probably apply loosely to Eligible Credit Support, which is te universe of collateral which, by rights, could be posted under the CSA even if it has not necessarily been yet.

The Basic Idea

The basic idea is that {{{{{1}}}|Credit Support}} creates an offsetting value under the CSA which, when set off against the net market exposure under the ISDA Master Agreement proper, would equal zero, or at any rate an acceptably low number: pre-agreed {{{{{1}}}|Threshold}}s, {{{{{1}}}|Independent Amount}}s, {{{{{1}}}|Minimum Transfer Amount}}s may intervene to make that number something other than zero, and {{{{{1}}}|Exposure}} and the value of extant {{{{{1}}}|Credit Support}} may subsequently change, but it will be in any case near zero.

Each party can run this calculation on, essentially, any Local Business Day. The person holding {{{{{1}}}|Credit Support}} must factor its value into its demand.

Where a party is seeking new {{{{{1}}}|Credit Support}} to cover its own outright Exposure, that is a “{{{{{1}}}|Delivery Amount}}”. Where it is seeking to “call back” {{{{{1}}}|Credit Support}} it has already delivered, that is called a “{{{{{1}}}|Return Amount}}”.

The difference between Delivering and Returning

There is not much of a difference, but there is some: with a {{{{{1}}}|Return Amount}}, the {{{{{1}}}|Transferee}} gets to choose which bit of {{{{{1}}}|Credit Support}} the {{{{{1}}}|Transferor}} sends back, out of what the {{{{{1}}}|Transferee}} originally delivered. When the {{{{{1}}}|Transferee}} is calling for a {{{{{1}}}|Delivery Amount}} the {{{{{1}}}|Transferor}} gets to choose from the agreed {{{{{1}}}|Eligible Credit Support}} table in the elections paragraph.

The self-help element is this: you don’t have to call for {{{{{1}}}|Credit Support}}. You may be entitled to, but it is up to you to run the calculations and make the demand. If you don’t, the other party is not obliged to send you anything.

Each party therefore also “marks its own homework”. Should the parties not agree on their respective valuations, there is a dispute resolution process set out in Paragraph {{{{{1}}}|4}}.

Paragraph 3(c) of the 2018 IM Credit Support Deed on margin mechanics

There is quite a lot in Paragraph 3 of the 2018 English law IM CSD, and rather than setting it all here, we have created a whole page for Paragraph 3(c), seeing as it has no equivalent in the variation margin CSAs.