Template:M summ 2016 CSA 5(c)(ii)

Interest Amounts under the 1995 CSA

It really ought to be quite simple, and in the 1995 CSA it is: if a 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 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 interest on any part of that Credit Support Balance increases its value and, since it was calibrated to equal an exposure exactly, ought to be spirited back to the Transferor: the Transferee otherwise would become indebted for the value of that interest to the Transferor, which for variation margin is not the idea.

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 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 nutshell to the right I have tried to simplify the drafting but I am a bit jet-lagged and it is testing even my patience. But know this: Interest Payment is a fiddly, time-and resource-consuming pain which will inevitably lead to error, confusion and name-calling. Interest Adjustment — just adding accrued interest to your Credit Support Balance — is far simpler and more elegant: none of this Kafkaesque complexities for netting and offsetting individual payments. It all comes out in the wash.

First, you have the choice between “Interest Transfer” and “Interest Adjustment”.

Interest Transfer

Here there is the choice of whether “Interest Payment Netting” applies. As far as the JC can tell, most market participants have switched this off, we surmise simply to avoid the torture of figuring out what you have to pay if it is switched on.

If Interest Payment Netting does not apply, then the Interest Payer must pay interest per the agreement in the elections (at Paragraph 11(g)(ii)), and note there is no proviso allowing you to cry off if paying this amount would create a new Delivery Amount.

If Interest Payment Netting does apply then descend we must into the labyrinthine mind of ISDA’s crack drafting squad™. The short point is that you must work out if, on the same date, the Interest Payer is due a cash payment under the 2016 VM CSA, and if so, net the two off and pay the balance. Again, no proviso for what happens if this payment would lead to a margin call from the Interest Payer.

Interest Adjustment

Interest Adjustment is a far simpler method: incoming interest is just added to the Credit Support Balance. If, on your next margin call, net, the Credit Support Balance exceeds your counterparty’s Exposure to you, you get your interest back through the normal mechanism of calling for a Return Amount. All the netting and offsetting happens automatically. The only contingency — and well spotted, ISDA’s crack drafting squad™, for this one is truly for details freaks — is if you receive negative interest on your Credit Support Balance such that it wipes out the Credit Support Balance entirely and is still unsatisfied, then the Interest Payer — and in the case of negative interest, this is the person Transferor, not the Transferee — has to pay the balance. But if you are accruing interest and calling for margin daily, the likelihood of that happening is extremely low, and it is hard to see why you couldn’t just add this to the usual margin call process as well (since it is likely to be a daily process).