(VM)
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The ISDA Credit Support Universe
The Jolly Contrarian holds forth™ Resources and Navigation
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God bless them, when ISDA’s crack drafting squad™ were deep in the ritualistic sacrifice phase of the Wording for the regulatory margin CSAs someone — we like to think it was Ser Jaramey Slizzard himself, but it is not documented — hit upon the idea of suffixing certain of the definitions in the Modern CSAs with “(VM)” — for “variation margin” — and (IM) — for “initial margin”.
So assiduous were those Fruty knyghtes of the Isdere that the expression features no fewer than 235 times across the 2016 VM CSA and a full 335 times across the 2016 NY VM CSA scattered like buckshot across the posterior of a frolicking trespasser caught in flagrante delicto in a field of barley by an angry farmer. Never frolic in a field of barley: it goes against the grain.
Here is what 335 VMs look like in a job lot:
(VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM) (VM)
This seems to us rather a waste of trees, and printer toner — a commodity more expensive per gram than enriched plutonium.
We are all environmentalists now: are there good grounds for such profligacy? As is usual for the squad’s lexical peccadilloes, the answer is “in theory, yes. In practice — perhaps once upon a time, if you tilt your head and screw your eyes quite tightly.
Regulatory margin was not something that anyone asked for. The financial services community had it imposed upon it, but the financial regulation community, in a fit of exasperation after the manifold disasters of the global financial crisis, the way a fearsome kindergarten teacher might order a truculent child to the naughty step or to wear an embarrassing hat for the afternoon.
Said truculent child did as truculent children do: instead of accepting its punishment with good grace, understanding it has erred, and treating the whole incident as a teachable moment, it did its best to work around it. Swap transactions that were already on foot before the commencement of the new regulations were “grandfathered” and were not, specifically, required to be margined. Certain classes of transaction — not many, in the end — were out of scope for compulsory margin. So the industry prepared for a world where single ISDA Master Agreement might have two CSAs: a regulatory one for in-scope products after the commencement date, and a non-regulatory one for grandfathered products and those out of scope after the commencement date.
What is the difference between regulatory and non-regulatory margin CSAs? Largely one of theory and not practice: a plain old Ancient CSA has a wide range of Eligible Credit Support, presumes you may set an Independent Amount (this is ISDAs traditional way of dealing with initial margin), and allows the parties to agree Valuation Dates more or less as they see fit and set often asymmetrical Thresholds, Minimum Transfer Amounts.
The new VM CSAs (and more importantly, the regulations with which they were designed to comply) assume each Local Business Day would be a Valuation Date each day, that your Thresholds will be zero, and that Eligible Credit Support will take the form of Cash in the Base Currency.
Now, in practice, old-style CSAs had in practice been converging on standard terms that were not so different from what the regulation required. Most were valued daily, with low Thresholds, and in cash. There might have been some advantages and balance-sheet efficiencies to be had from sticking to l’ancien regime, but they were not as stark in practice as they look in theory.
And operations people noticed that exchanging cash only is a whole lot easier, settles quicker, and is less volatile and easier to value than securities, but it is also not nearly as expensive as it seemed in principle: in client facilitation business, generally for every dollar posted out the door one comes in from someone else, so the net funding consequence of posting in cash was muted.
Now running two CSAs on the same ISDA is a recipe for confusion. The whole point of a Credit Support Document is to be a single aggregating force, aggregating and boiling down all these diverse exposures and liabilities to a single number, and now there were two Credit Support Balances, two sets of Credit Support Eligibility Criteria, two Credit Support Balances and so on: in fact, twenty duplicated terms in the 2016 NY VM CSA and its ancient equivalent (seventeen for the 2016 VM CSA).
You can imagine this could become very difficult for the poor bugger in ops that is handling two sets of collateral flows across 25,000 ISDA arrangements.
ISDA’s crack drafting squad™’s elegant solution was to suffix the regulatory margin versions of these terms — what we call the “Modern CSAs” with “(VM)”. Result: a lot of (VM)s. ISDA’s prose in the CSAs — especially the Modern CSAs — is purple enough without these ugly parentheticals.
But needed, right? Are we now in a world of parallel CSAs, carefully arbing the regulatory rules? It is difficult to know definitively — ISDA Master Agreements are private contracts — but anecdotally, it seems not. Almost all of the “grandfathered” legacy business would have rolled off or rolled into in-scope Transactions quickly after the effective date for the regulations. Seeing as almost all products were in scope for the regulations, it seems unlikely that many parties would have stuck with an Other CSA for a tiny portion of their FX trading businesses. We are not saying none — but leaving these fossil remnants of a brief transitionary period in these documents feels a regrettable step.