Credit Support Obligations - VM CSA Provision
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2016 ISDA Credit Support Annex (VM) (English law)
Paragraph 2 in a Nutshell™ Use at your own risk, campers!
Full text of Paragraph 2
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Content and comparisons
The key difference: No Credit Support Amount. Instead, it just references the Counterparty’s Exposure.
Summary
1995 CSA
Under a 1995 CSA the Credit Support Amount is the total amount one counterparty must have delivered to the other at any time: the combination of the Exposure to that party and the net Independent Amounts it must post, minus any agreed Threshold.
No equivalent in the 2016 VM CSA
There is no concept of a Credit Support Amount in the 2016 VM CSA because the Credit Support Amount a party may require is no more than its Exposure to the other party — as already defined in the 2016 VM CSA. In the old 1995 CSA one had to consider any pertinent Independent Amounts and the agreed Threshold.
No Independent Amounts
Life is much simpler in the world of regulatory variation margin for which the 2016 VM CSA is designed. Its only concern is variation margin. That is, there are no Independent Amounts.[1] In the old 1995 CSA, Independent Amounts were there to protect counterparties against potential swings in Exposure that might happen before the next margin call: that is, they are a buffer against the risk of market moves.
But in the old world, Independent Amounts were transferred outright to the Transferee, by title transfer.[2] This created a conceptual issue for regulators, who were trying to minimise credit exposure between the parties: a title transfer of collateral to cover an Exposure that doesn’t yet — and might never — exist creates a negative exposure, because the holder of an Independent Amount would be indebted to the Transferor for its return.[3]
All that said, there is a custom-built addition in Paragraph 11[4] that lets you build an Independent Amount concept back in if you really want one. And who, in their right chicken-lickeny mind, wouldn’t?
No Threshold either
And what about the Threshold? Well, there shouldn’t be one of those either: The thrust of the margin reforms in the different jurisdictions was to require counterparties to collateralise their total mark-to-market exposure, not just most of it, so in a rush of uncharacteristic blood to the head, ISDA did away with the concept altogether. There is usually some flex in the regulations, and don’t be surprised to see your more tempestuous counterparties hotly insisting on a Threshold, even just a nominal one.
So the Credit Support Amount vanishes, in a puff of logic and existential redundancy.
General discussion
See also
References
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ISDA 2016 English Law VM Credit Support Annex
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Crosscheck: Credit Support Obligations in a Nutshell™ Original text:
Resources and Navigation
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Overview
Between US and English law
Here is a comparison between the 1994 NY CSA and the 1995 CSA. The differences are largely down to the security interest versus title transfer — you know Pledgor versus Transferor and so on.
Betweem OG and VM
The key difference between the OG CSAs and the 2016 VM versions: there is no Credit Support Amount concept in the 2016s, seeing as there is no initial margin to reference. (Right?) Instead, it just references the Counterparty’s Exposure.
Summary
The overall vibe of a Credit Support annex is self-help.
It is presumed on any day there will be a portfolio of Transactions outstanding under the ISDA (not counting the CSA itself, which under the English law construct, is also a “Transaction”, though it is not under a NY law construct), and these Transactions will each create a market exposure, and when those market exposures are summed, will create an overall “Exposure” owed by one party or the other.
The party to whom the netted amount would be paid were the ISDA Master Agreement closed out on that day can — subject to a few conditions — call for Credit Support from the party who would be due to pay it.
The basic idea is that Credit Support, once paid, would create an offsetting exposure under the CSA which, when set off against the net market exposure under the substantive Transactions, would equal zero, or at any rate an acceptably low number: pre-agreed Thresholds, Independent Amounts, Minimum Transfer Amounts may intervene to make that number something other than zero, and Exposure and the value of posted Credit Support may subsequently change, but it will be in any case near zero.
Each party can run this calculation on, essentially, any Local Business Day. Once Credit Support has been posted, the person holding it must factor this Credit Support Balance into its demand. Where a party is seeking to “call back” Credit Support it has already posted, that is called a “Return Amount”. Where it is seeking new Credit Support to cover its own outright Exposure, that is a “Delivery Amount”.
(There is not much of a difference, but there is some: where you are calling back Credit Support under a Return Amount, the Transferee gets to choose which bit of Credit Support the Transferor sends back, out of what the Transferee originally posted. When the Transferee is calling for new Credit Support to cover an outright exposure, the Transferor gets to choose what Credit Support it sends from the agreed Eliigible Credit Support in the elections paragraph).
The self-help element is this: you don’t have to call for credit support. You are entitled to, but it is up to you to run the calculations and make the demand. If you don’t, the other party is not obliged to send you anything.
Each party therefore also “marks its own homework”. Should they not agree on their respective valuations, there is a dispute resolution process set out in Paragraph 4.
Title transfer versus pledge
The English law CSAs generally operate under a title transfer construct, where the Credit Support is delivered outright against a contingent obligation on the Transferee to return “equivalent” — meaning fungible — Credit Support. As such, the Transferor has no legal or beneficial interest in Credit Support it has posted: it has only a debt claim against the Transferee for its return (which would be netted off against the Transferee’s debt claim against it under the ISDA Master Agreement). This is why an English law CSA is treated as a Transaction: it is, in every sense, identical to a physically settled asset swap.
The New York law CSAs operate as a security interest in the form of a pledge: Credit Support is posted by way of security, and the Transferee takes only legal title, holding beneficial interest in the Credit Support for the Transferor. This markedly changes the netting analysis. But — unless the option has been disapplied in the elections paragraph, the holder of pledged Credit Support is entitled to “rehypothecate” it — transfer it outright to a third party, against an obligation to return a fungible asset — and while U.S. attorneys may beg to differ this, to a jaundiced English lawyer, makes a NY law CSA materially identical to an English law one. Both are effectively, title transfer.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays
- A deeper dive into the reason the Credit support Amount disappeared from the VM CSAs.
See also
- Credit Support Amount (if you have an OG CSA)
References
- ↑ Well, alright, should be no Independent Amounts.
- ↑ Under Engliush law CSAs, at any rate. But the effect was the same where rehypothecation was allowed under a 1994 NY CSA too.
- ↑ Hence, regulatory initial margin cannot be cash, and must be pledged and not title transferred.
- ↑ For more information see Credit Support Amount (VM/IA).