Exposure - CSA Provision

ISDA 1995 English Law Credit Support Annex →Go uptown In a Nutshell™ Section Exposure: “Exposure” means, for a party on a Valuation Date, any amount payable to it by the other party (if so, a positive number) or by it to the other party (if so, a negative number) under Section 6(e)(ii)(1) were all Transactions (other than the CSA) being terminated at the Valuation Time, assuming that: (i) it is not the Affected Party and (ii) the Base Currency is the Termination Currency; where the Valuation Agent will determine Market Quotations based on its mid-market estimates for Replacement Transactions (as contemplated in “Market Quotation”). view template 1995 CSA full text of Section Exposure: “Exposure” means, with respect to a party on a Valuation Date and subject to Paragraph 4 in the case of a dispute, the amount, if any, that would be payable to that party by the other party (expressed as a positive number) or by that party to the other party (expressed as a negative number) pursuant to Section 6(e)(ii)(1) of this Agreement if all Transactions (other than the Transaction constituted by this Annex) were being terminated as of the relevant Valuation Time, on the basis that (i) that party is not the Affected Party and (ii) the Base Currency is the Termination Currency; provided that Market Quotations will be determined by the Valuation Agent on behalf of that party using its estimates at mid-market of the amounts that would be paid for Replacement Transactions (as that term is defined in the definition of “Market Quotation”). view template Related Agreements Click here for the text of Section Exposure in the 1995 English Law CSA Click here for the text of Section Exposure in the 2016 English Law VM CSA Click [[{{{3}}} - NY VM CSA Provision|here]] for the text of the equivalent, Section [[{{{3}}} - NY VM CSA Provision|{{{3}}}]] in the 2016 NY Law VM CSA Comparisons 1995 CSA and 2016 VM CSA: click for comparison {{nycsadiff {{{3}}}}} Resources Full wikitext | Nutshell wikitext Navigation 1 (Interpretation) | 2 (Credit Support Obligations) | 3 (Transfers, Calculations and Exchanges) | 4 (Dispute Resolution) | 5 (Title Transfer etc) | 6 (Default) | 7 (Representation) | 8 (Expenses) | 9 (Miscellaneous) | 10 (Definitions) | 11 (Elections and Variables) Index: Click ᐅ to expand: 1995 CSA Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

The total mark-to-market exposure under your ISDA Master Agreement on a given day, not counting anything posted by way of credit support. That is, Exposure omits the mark-to-market exposure of the transaction comprising the 1995 CSA itself, because that would entirely bugger things up: the MTM of an ISDA including the CSA is, of course, more or less zero.

Discussion

• Market Quotation? But I have a 2002 ISDA:Note the references to Market Quotation and other 1992 ISDA specific things. If you are under a 2002 ISDA, these should be corrected. Of you could sign up to the 2002 ISDA Master Agreement Protocol and that would do it for you. In the 2016 VM CSA, note both versions of the ISDA Master Agreement azre provided for in the alternative.
• Mid-market?: A slight cognitive dissonance: It talks about your 6(e)(ii) amount - which is generally your replacement cost, at your side of the market, but then goes on to say determined at the mid-market price...

Relevance of Section 6 to the peacetime operation of the Credit Support Annex

The calculation of {{{{{1}}}|Exposure}} under the CSA is modelled on the Section 6(e)(ii) termination methodology following a Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.

This means you calculate the {{{{{1}}}|Exposure}} as:

(a) the Close-out Amounts for each Terminated Transaction plus

(b) Unpaid Amounts due to the Non-defaulting Party; minus

(c) Unpaid Amounts due to the Defaulting Party.

There aren’t really likely, in peacetime, to be Unpaid Amounts loafing about — an amount that you are due to pay today or tomorrow wouldn’t, yet, qualify as “unpaid”, but would be factored into the Close-out Amount calculation.

There is a little bit of a dissonance here, since “{{{{{1}}}|Exposure}}” is a snapshot calculation that treats all future cashflows, whether due in a day, a month or a year from today, the same way: it discounts them back to today, adds them up and sets them off. Your {{{{{1}}}|Delivery Amount}} or {{{{{1}}}|Return Amount}}, as the case may be, is just the difference between that Exposure and whatever the existing {{{{{1}}}|Credit Support Balance}} is. The future is the future: unknowable, unpredictable, but discountable, whether it happens in a day or a thousand years.

All the same, this can seem kind of weird when your CSA you have to pay him an amount today when he owes you an even bigger amount tomorrow. It’s like, “hang on: why am I paying you margin when, tomorrow, you are going to be in the hole to me? Like, by double, if I pay you this margin and you fail to me tomorrow.”

The thing which, I think, causes all the confusion is the dates and amounts of payments under normal Transactions are deterministic, anticipatable, and specified in the Confirmation, whereas whether one is required under a CSA on any day, and how much it will be, depend on things you only usually find out about at the last minute. CSA payments are due “a regular settlement cycle after they are called” — loosey goosey, right? — (or even same day if you are under a VMV CSA and you are on the ball with your calls) whereas normal swap payments are due (say) “on the 15th of March”

So, a scenario to illustrate:

• Day 1: Party A has an {{{{{1}}}|Exposure}} — is out of the money — to the tune of 100. Its prevailing {{{{{1}}}|Credit Support Balance}} is 90, so (let’s say, for fun, after the {{{{{1}}}|Notification Time}} on the {{{{{1}}}|Demand Date}}) Party B has called it for a {{{{{1}}}|Delivery Amount}} of a further 10, which it must pay, but not until tomorrow.
• Day 2: Meanwhile, Party A has a Transaction payment of 10 that falls due to Party B, also tomorrow. The arrival of this payment will change Party A’s Exposure to Party B so it is 90. Assuming Party A also pays the Delivery Amount, by knock-off time tomorrow it will have posted a {{{{{1}}}|Credit Support Balance}} of 100, and its Exposure to Party B will only be 90. This means it will be entitled to call Party B for a {{{{{1}}}|Return Amount}} of 10.

This seems rather a waste of operational effort, and will also take years off your credit officer’s life and may even cause his hair to catch fire. Can Party A just not pay the further Delivery Acount in anticipation of what will happen tomorrow?

Fun times in the world of collateral operations.

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 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? It might be better, but “better” is not how ISDA documentation rolls. The theory of the ISDA and CSA settlement flows puts the Transaction payment egg before the variation margin chicken so, at the moment, Transaction flows and collateral flows tend to be handled by different operations teams, and their systems don’t talk. Currently, the payer of a terminating transaction has its heart in its mouth for a day or so.

Industry efforts to date have been targeting at shortening the period between the Exposure calculation and the final payment of the collateral transfer.