Template:ISDA transaction and collateral flows

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 out 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? Of course not. Now there is a burgeoning DTCC product designed to do that — it is in its infancy — but the theory of the ISDA and CSA settlement flows puts egg before chicken and, at the moment, Transaction flows and collateral flows tend to be handled by different operational parts of an institution, and their systems don’t talk.

Anyway, currently, the payer of a terminating transaction has its heart in its mouth for a day or so.