Transaction terminations and VM
|
2016 VM CSA Anatomy™
|
Now the timings of the various payments under the ISDA architecture lead to one rather odd effect:
If you have an existing Transaction with a large MTM exposure, that is currently collateralised with variation margin, as it almost certainly will be, and then the in-the-money party decides to realise the value of that Transaction (or — I dunno — the swap just gets to its scheduled termination date, then you have a coupole of opposite things that have to happen.
- The out-of-the-money counterparty has to pay the termination value of the Transaction; and
- The in-the-money counterparty has to repay a corresponding portion of the variation margin it has already posted on the Transaction
These two amounts should be — intra-day market moves permitting — the same. It stands to reason: the point at which I finally pay you your winnings in the swap casino, you must pay me back the cash I gave you as collateral for the value of the position you just won on.
Hang on: but these just offset, don’t they?
Well, you would like to think so. The JC did, the first time someone asked his this question, and when he went to run it down he got quite the surprise. In our modern age of limiting systemic risk, you would like to think cash I had already paid you to reflect the value of your trade would seamlessly offset against the value I would have to pay you on termination: you keep the cash value of that variation margin, maybe there’s a small true up payment to cater for the market movement since the last collateral exchange, I discharge you from returning the VM I have posted you, and we’re all square.
But that’s not how ISDA’s crack drafting squad™ played it.[1] Instead the OTM counterparty must pay out the whole value of the swap mark to market — like, again — then wait for a new opportunity to value the master agreement, tomorrow, and then call for the equivalent credit support back then.
This leads to enormous overnight exposure, but this is the way the market seems to have operated since credit support annexes were a thing.
See also
References
- ↑ In fairness, the mechanics were first designed in an innocent, primordial era where variation margin was barely even an idea let alone the regulatory mandatory behemoth it is today. So they weren’t really to know.