Independent Amount, Threshold and Minimum Transfer Amount - NY VM CSA Provision
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2016 ISDA Credit Support Annex (VM) (New York law)
A Jolly Contrarian owner’s manual™ IA Threshold MTA in a Nutshell™ Original text:
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Overview
Even when it was just about Thresholds, this was one of the most popular pages on this whole site. Even more popular than the one about Toto. And Rick Astley. Now we have wrapped in all this stuff about IA and MTA we expect it to be bringing down servers from Bucharest to Belgium. Go figure, my little contrarians.
Summary
Okay. Now in a CSA, beyond your basic Exposure and how much Credit Support you have already posted, there are three — well, if you count Rounding, three-and-a-half — levers determining what you will have to post, or may call, in the future. These are:
- Independent Amount or “IA”: How much do you have to leave with the other guy, over and above your mark-to-market Exposure, to make things nice. There isn’t an Independent Amount in a modern variation margin CSA for reasons canvassed in the premium content.
- Threshold: Is there any lower limit of Exposure that you might have to wait for before being able to call, or be obliged to post, variation margin. There isn’t a Threshold in a modern variation margin CSA, either, for reasons also canvassed in the premium content. But they are somewhat related.
- Minimum Transfer Amount or “MTA”: Assuming you are over your Threshold, is there a “smallest integral amount” of incremental Exposure that must arisen before a posting obligation arises and anyone has to go to the trouble of paying out?
- Rounding: Somewhat related to this is the question of Rounding where the Transfer Amount gets rounded up or down to a whole number, so no one has to be rifling down the back of the sofa for shillings and pence. Oddly, this appears only in the Elections, and not in the Credit Support Obligations section itself. In any case, these days rounding is typically to the nearest whole unit of currency — dollar, euro, pound; back in the day it might have been a hundred or a thousand — but not in any case the sort of thing one would expect to send a counterparty over the edge, Mr. Creosote references notwithstanding.
These three levers do different things: Independent Amount is what is now colloquially referred to as initial margin: it is a buffer that just sits there for a rainy day. Threshold allows you to set a point where okay yes my credit people are now officially freaking out and you need to make them less freaky fast. So the Threshold will typically be a big number. You cross it once, and the CSA starts up. If you drop below it, the CSA stops again. If one or other party wishes to never post Credit Support (did happen, not really nowadays with regulatory VM, but there is the odd NFC in this bucket) you would set your Threshold at “Infinity”. The Minimum Transfer Amount is usually a small, round number (say USD1m, or USD5m) that reflects the fact that small movements in Exposure are not really worth getting your collateral ops steampunk machine fired up for.
Isn’t Threshold something to do with Cross Default?
Well, it is, but that is different: that is the Threshold Amount: The Threshold in the CSA is a different thing. They are both thresholds, but ISDA’s crack drafting squad™ might have used a different word.
A bit late now, however, but the JC thesaural service came up with “knock-in level”, or “floor”, or “gate”, or “trigger”, or “hurdle”. Or, yes, threshold.
Is “Independent Amount” different from “initial margin”?
On the face of it, it looks that way, doesn’t it. But no.
If you look at it cold, the Independent Amount, especially as written in the OG CSAs, looks like a fixed currency amount that is paid at the beginning of a relationship, irrespective of how many Transactions you may have on — and even if you have none on. As conventionally understood, “initial margin” is, by contrast, Transaction-specific, being calculated by reference to the liquidity and volatility of the specific Transaction to which it relates.
But the OG CSAs don’t have a concept of “initial margin”, and it quickly became clear no one in their right mind would send their swap dealer a wodge of money just to commemorate the signing of an ISDA Master Agreement, exciting though that event may be. Perhaps ISDA’s crack drafting squad™ of 1994 and 1995 lived in a kinder, more naïve time — one more impressionably swooned by the conclusion of a negotiation than our own — or maybe they were just blitzed when they came up with the idea.[1]
In any case, what the market has done since the Children of the Woods first produced that nutty Independent Amount concept is to bend the squad’s fantastical verbal engineering so it works like Transaction-specific initial margin. So, the Independent Amount will be usually defined as “an amount agreed between the parties in relation to each Transaction, or as otherwise advised by Party A”,[2] which rather kicks the issue in to touch. In practice, it’s likely to be articulated as a multiplier on notional, will be required of the client by the swap dealer and not the other way around, will be payable at the start of each Transaction, and may be adjustable on the fly.
For example, a dealer who sets an Independent Amount by reference to the perceived volatility of the Transaction might reserve the right to increase IA should that volatility unexpectedly change. You can be sure more than one risk officer embarked on an undignified scramble for her margin tables — and put in a desperate call to Legal — the day UK decided Brexit meant what it said and sterling gapped down 8%.
Particularly where underlying trades and markets are volatile, expect to see much customisation of the Independent Amount: It might be calculated by reference to a given multiplier for a given asset class: it is not uncommon to see tiering in FX transactions, for example, where Transactions on currencies in the highest tier might have a bigger multiplier that those on lower tiers.
Especially where one counterparty is providing access to markets for the other party (so-called synthetic prime brokerage) there may be a provision that the calculation agent can adjust tiers, multipliers, and the assets which are eligible for each tier in its discretion, and with effect to existing as well as new transactions. This can have the effect of retroactively adjusting Independent Amounts, in which case the difference can be called under the CSA’s ordinary Transfer provisions.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays
- A bit more on Independent Amounts and Threshold Amounts
- A step through the calculations of the Credit Support Amount, playing will all the Independent Amounts, Minimum Transfer Amounts and Thresholds. Fun!
See also
- Perhaps you seek enlightenment about the 2018 English law IM CSD? If so, brave chicklings, there is a nascent anatomy of it here.
References
- ↑ This isn’t an entirely outlandish speculation: how else can you rationalise their formulation of Indemnifiable Taxes, for example? It was the “naughty nineties”, after all.
- ↑ Being the dealer, of course.