Default - CSA Provision
1995 ISDA Credit Support Annex (English Law)
Paragraph 6 in full
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The default paragraph explains how you value the 1995 English Law CSA itself — being a Transaction in its own right, of course — when closing out an ISDA Master Agreement. The basic gist is that you treat the Credit Support Balance as of the Early Termination Date — being the total value of the Credit Support you have ponied up at any time — as an Unpaid Amount, rather than treating is as a contingent return obligation, the present value of which would go into the Close-Out Amount (or Loss, or Market Quotation, if you still labour under an antediluvian 1992 ISDA).
Why does it reference “Unpaid Amounts”?
The 1995 English Law CSA is technically a Transaction under the ISDA Master Agreement in its own right — that is deep ISDA lore — but it is still a weird Transaction, and the standard “replacement cost” method of valuation doesn’t work brilliantly: rather than having defined payments upfront, each of which can be valued and discounted back to now to reveal a present value, payment obligations under a 1995 English Law CSA depend on the aggregate discounted cashflows of all the other Transactions under your ISDA Master Agreement which the 1995 English Law CSA covers. So good luck determining, in the abstract, the replacement cost of something like that.
But the good news is you don’t have to: the Credit Support Balance isn’t calculated by reference to its own discounted future cashflows: rather, it is just the inverse of the aggregate present value of all the other Transactions under the ISDA Master Agreement. So the “replacement cost” on any day is just the prevailing value of the Credit Support Balance. It’s easier to treat that as an Unpaid Amount (none of this tedious mucking about with replacement costs and so on). But that means you have to deem the Close-Out Amount as zero.
Including “comprehensive” Termination Events
Consider expanding of the 1995 English Law CSA provision to include “Termination Events where all Transactions are Affected Transactions”. This is as per Section 3.2 of the 2001 ISDA Margin Provisions which recommend that Paragraph 1995 English Law CSA of the CSA should apply where all Transactions are closed out following an Event of Default or “Specified Condition” — the latter of which is defined to include the Termination Events listed under the ISDA Master Agreement. It is likely that all Transactions would be Affected Transactions should a Credit Event Upon Merger or Additional Termination Event occur.
- Or Market Quotation/Loss, if under a 1992 ISDA. Spoddy point: the definition of “Loss” in the 1992 ISDA includes the “Unpaid Amount” concept in the definition: “Loss includes losses and costs (or gains) in respect of any payment or delivery required to have been made (assuming satisfaction of each applicable condition precedent) on or before the relevant Early Termination Date and not made...”