Margin Amount (IM); Margin Amount (IA); Margin Approach - IM CSD Provision
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2018 ISDA Credit Support Deed (IM) (English law)
A Jolly Contrarian owner’s manual™ Margin Amount and Approach in a Nutshell™
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ABANDON HOPE ALL YE WHO ENTER HERE.
The ungainliness of its title gives the game away, but this clause is ISDA’s crack drafting squad™’ characteristically elegant way of untangling a skein it has just created by overreaching its necessary scope. As such, in all the thick galaxies of swap discombobulation, this clause is unprecedented in the ISDA expanded universe. For that, frankly, we can thank the good lord in heaven, or Midichlorians, of whoever the sad, omnipotent bastard is that gives life force to the Way Of The ISDA.
“Game For A Laugh” drafting
From Wikipedia:
British TV show Game For A Laugh revolved around a variety of practical jokes, often as elaborate set-ups on unsuspecting members of the public, either studio-based or shot on location. Studio games included the “Dunk Tank”, “Glube Tube”, “Pie Chair”, and “Comprehend the ISDA clause” in which varying amounts of mess were dealt out. Each segment would end with the hapless victim negotiator being made aware of the joke by a member of ISDA’s crack drafting squad™, who would then announce that negotiator had proved to be “game for a laugh!”
Basics
Margin Amount (IM)
Margin Amount (IM) is the snappy, memorable label for that portion of one’s initial margin burden that is imposed directly by one’s local regulators. This is the compulsory part of initial margin that you have to pony up, by law, even if neither you nor your counterparty want to. It would be nice had the drafting said this a little less obliquely — you know, they might have called this “Regulatory IM”, even, but look: I wish feijoas grew in England, and that won’t happen either, so there’s no point getting upset about it.
A Chargor must post Margin Amount (IM) to a third party Custodian (IM) who will hold it out of harm’s way and subject to a security interest in favour of the Secured Party and an account control agreement determining who gets to say what happens to it and and when.
Since it is held out of harm’s way, neither the Chargor nor the Secured Party can use it, and it sits immobilised, a permanent dead weight on the capital efficiency of the world’s financial markets. But everyone is safer that way — unless you are a hardcore modernist, a little redundancy is no bad thing — so we shouldn’t feel too bad about it.
To be contrasted and not, however easy it may be, confused with Margin Amount (IA).
Margin Amount (IA)
Margin Amount (IA) is the portion of one’s initial margin burden that no-one (except your dealer) made you pay.
As such, you usually transfer Margin Amount (IA) directly to the swap dealer, if you are a limey (or under the influence of the lime-peddlers), by means of title transfer and not pledge, and almost certainly your dealer won’t agree to give you any Margin Amount (IA) for any exposure you feel you have to it. If you are a particularly big or stampy-footed customer, you might persuade your dealer to use the Greater of Margin Flow (IM/IA) Approach, in which case you will pay all this extra non-regulatory initial margin to the Custodian (IM) as well the regulatory initial margin and all of it will be held out of harm’s way, though be careful for what you wish for: your dealer may charge you bigger spreads as a result because it can’t optimise its funding position on initial margin you haven’t physically given it.
Towards more picturesque drafting™
“... a posting obligation of a Chargor, the Base Currency Equivalent of an amount equal to the sum of the Independent Amounts (as defined in any Other CSA) applicable to the Chargor and any other amounts applicable to the Chargor (other than any amounts in respect of Margin Amount (IM) or Exposure), however described, intended by the parties to operate as an Independent Amount ...”
If that were not bamboozling enough, how about this for the avoidance of doubt incluso which does nothing but introduce doubt into a clause already wracked with enough confusion and bitterness for your average bear:
“For the avoidance of doubt, in order to determine the amounts “applicable to the Chargor” for the purposes hereof, the parties will take into account the effect of any conditions precedent applicable to such amounts.”
My best guess is that this means, “where payment of independent amount depends on something happening, then you only count it if that something has happened.” Like, you don’t say, fellas.
This is the organisation that wants to standardise all financial products across the market, readers.
What a world we live in.
Para 3(c) Margin Approach
Para 3(a) is the point where, with the greatest of respect, the ISDA’s crack drafting squad™ got totally over the front of their skis. Had they just reined in their enthusiasm, and limited themselves to dealing with *just* regulatory IM, that actually has to be posted, compulsorily, to a third-party custodian, this document would have been shorter, less controversial, and way easier to understand. But no: they went into bafflement overdrive.
A casual reader might also wonder whether someone is having a laugh, at our expense, about how these undoubtedly overcomplicated provisions are expressed. ISDA’s crack drafting squad™ could scarcely have made this more convoluted, as our nutshell summary to the right should indicate.
Initial margin and independent amounts
A common confusion in the ancient CSAs used to be the use of “Independent Amount” to describe what everyone else in the market colloquially calls initial margin. Were they the same? Were they different? It was difficult, on a cold read to say. Especially as an {imcsdprov|Independent Amount}} looks like it is meant to function as a distinct amount of standalone credit protection, held without reference to a given Transaction, but in practice it never works that way. Counterparties set and call Independent Amounts on a Transaction-by-Transaction basis. (For further discussion, see Independent Amount.)
Anyway, ISDA’s crack drafting squad™ has “solved” that problem by introducing two kinds of “Margin Amount” in the 2018 English law IM CSD, and giving them ugly parenthetic suffixes: the Margin Amount (IM) and the Margin Amount (IA). Maybe someone thought this was a neat trick, I don’t know. It seems a dumb one to JC: where, once upon a time, everyone knew Independent Amount and initial margin were, for all intents and purposes, the same; now they are subtly different.
The problem ISDA’s crack drafting squad™ was trying to “solve for” was the swap counterparty who is already taking initial margin and wants to keep doing that, its own way, somehow, even now the technocrats have railroaded their way into the room and mandated by regulation their own version initial margin, which you must do their way.
These counterparties include, for example, those in a prime brokerage relationship, who might have their swap positions “cross-margined” with a wider range of physical and futures positions that their prime brokers will want to margin — and rehypothecate — as a single pool of assets and liabilities.
But it might be as simple as a dealer who has set its Independent Amounts higher than those mandated by the regulators, and wants to keep the higher value.
So the 2018 English law IM CSD contemplates, on one hand, regulatory initial margin, which it calls “Margin Amount (IM)”, and non-regulatory initial margin, which it labels with fond redolence to the old days of Independent Amounts, as “Margin Amount (IA)”.
The theory of the Margin Approach
Let’s call your existing, pre-regulatory, contractual initial margin arrangement your “IA”, and the regulatory requirement “IM”. IA could be more than IM, less than IM, or (unlikely, but let’s say) the same. Now everyone must post at least IM, so the only realistic scenarios are (i) those who want extra IA over the regulatory-prescribed IM, and (ii) those who don’t.
The other difference is that usually you paid your IA directly, and by title transfer, to your counterparty. Since, generally, dealers would require IM, but customers would not, this had the curious effect of increasing the customer’s credit exposure to the dealer, at the same time it reduced the dealer’s market exposure against the customer. But — and for that very reason — you must pay regulatory initial margin not to your dealer, but to a third-party custodian, under a security arrangement and an account control agreement, to avoid exacerbating counterparty credit risk the other way.
The regulatory regime is therefore economically not the same as the previous non-regulatory IA regime, as the recipient cannot monetise the regulatory initial margin it receives, or use it elsewhere in its business. This reuse right is important for those involved in margin lending.
So once the regulatory initial margin comes in, the question becomes: do you still want your old IA delivered to you personally, so you can reuse it — in total, or just any of it in excess of the new regulatory IM requirement?
The 2018 English law IM CSD proposes three ways of solving this:
- Distinct Margin Flow Approach: you pay IM under the 2018 English law IM CSD and pay the whole IA whack, separately, to the counterparty under the Other CSA. Obviously enough, customers are not going to like this.
- Allocated Margin Flow Approach: you pay the Reg IM portion of the IA under the 2018 English law IM CSD, and pay any excess over that in the IA to the counterparty under the Other CSA. To the JC’s way of thinking, this is the only one that makes any sense;
- Greater of Margin Flow Approach: You pay the whole of the IA (or the IM, if it is greater) under the 2018 English law IM CSD and nothing under the Other CSA. We don’t think the broker will ever give up the right to reuse excess IA by steering that to a third party custodian, and nor, really should the client, since their implied financing rates will surely rise.
Allocated Margin Flow is the best bet
To follow the contorted logic here you have to keep in mind that the Credit Support Amount (IM) comprises the Margin Amount (IM) — being the amount actually required as regulatory initial margin under the relevant regulatory regime by the counterparty in question, and the Margin Amount (IA), which is any extra initial margin — what in the old days we used to call an “Independent Amount”
We think that almost all punters will go for the Allocated Margin Flow approach as this best deals with the regulatory obligation without unduly penalising either side or changing the basic economics — though where the Secured Party would otherwise be in the rehypothecation game, it does change the economics a bit — thus, render unto CESR what is required by CESR;[1] pay any excess over that to your counterparty.
It leaves one rather arid and academic dispute that one may quickly tire of having, as to whether the excess should be over one’s Credit Support Amount (IM) — being the amount one is obliged to post to the Custodian (IM) by way of regulatory margin — or one’s Posted Credit Support (IM) — being the amount one actually has posted to the Custodian (IM) — these may be different if you are in the habit of operational laxity in providing Reg IM or reclaiming it when it is no longer required, or you have just blown up and missed a call — and we consider this further below.
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See also
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References
- ↑ This was ALMOST an awesome pun. It doesn’t quite work, seeing as (a) the Committee of European Securities Regulators was formally disestablished in 2011 and replaced by ESMA; and (b) you render your Reg IM unto a custodian, not to ESMA (or CESR) anyway. But still, it was close enough to roll the dice on it anyway Hope you like it.