Eligible Credit Support - CSA Provision
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ISDA 1995 English Law Credit Support Annex
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Crosscheck: Eligible Collateral in a Nutshell™ Original text:
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Overview
“Eligible Collateral” is to an American CSA what “Eligible Credit Support” is to under an English law title transfer CSA. So:
- 1994 NY CSA: Eligible Collateral
- 1995 CSA: Eligible Credit Support
- 2016 VM CSA: Eligible Credit Support (VM)
- 2016 NY VM CSA: Eligible Collateral (VM)
- 2018 IM CSD: Eligible Credit Support (IM)
We find all this (VM) and (IM) suffixing fairly infuriating so won’t usually bother with it.
Summary
Eligible Credit Support — with or without the (VM) suffix, and finding it tremendously irritating as he does, JC will largely go without — is what is, or is not, acceptable to post under a CSA. In the olden days, this was all a bit fraught and accounted for much of the practical complication of the CSA, and which (in the JC’s eyes) made it a sort of primordial smart contract, long before there were such things as smart contracts.
First, a terminology check. Bless them the NY CSA and the English law CSA use different labels for essentially the same things: Eligible Credit support (British) is the same idea as Eligible Collateral (American). This appears to be a matter of pure preference and you would like to think the ’squads could have duked it out in the mid-Atlantic in 1995 to something but WE ARE WHERE WE ARE.
In any case, an ancient CSA governs a deterministic, but nonetheless highly complicated flow of securities and currencies back and forth between counterparties daily, based on the Exposure of their portfolios. (Modern VM CSAs are simpler, as they are cash only).
In the ancient CSAs this is all very contractual and cash and a variety of types of corporate and government bonds might be acceptable; in the modern CSAs even though it looks like you can choose what you like, right, regulators’ rules, market conventions mean in practice variation margin is limited to cash in certain currencies. This makes a lot of the erstwhile complication and Ballschmerzen of CSA operations goes away.
Oh, go on: let’s have a table:
| CSA Year | Margin | Gov. Law | Holder | Eligible Collateral |
|---|---|---|---|---|
| 1994 | IM and VM | NY | Other party | Cash, Government Securities, Investment Grade Corporate Debt |
| 1995 | IM and VM | English | Other party | Cash, Government Securities, Investment Grade Corporate Debt, Equities |
| 2016 | Reg VM and optional IM | NY | Other party | Cash only (in practice) |
| 2016 | Reg VM and optional IM | English | Other party | Cash only (in practice) |
| 2018 | Reg IM only | NY | Custodian | Cash, government bonds, corporate bonds |
| 2018 | Reg IM only | English | Custodian | Cash, government bonds, corporate bonds |
You may wonder why regulatory VM is cash and Regulatory IM is usually securities and why you have to post Reg IM to a third party — if you are asking that, then for a half a pint a week you can subscribe and find out.
In nay case, who has to pay whom on any day, and what, is derivative — I know, right — of a load of extraneous factors besides that Exposure as a bare number: the “shape” of the derivatives book, the state of the market, the composition and market valuations of the Credit Support Balance already posted. Even a small firm will have multiple brokerage counterparties; a swap dealer will have hundreds of thousands. There is simply no way of monitoring and accurately performing an arrangement as complicated as a Credit Support Annex manually. Only computers can do it. Hence, it is rather like a smart contract, and not just superficially, but practically: the “contract” as a meaningful thing is the operational reality, not the document. It lives in the configurations the parties’ operations teams punch into their respective collateral management applications.
If a number is mis-punched, or the application does not or cannot reflect what is stipulated on paper in the Credit Support Annex, no one will ever know. At least, not until it is too late.
If your counterparty is a smoking ruin and you find out the Credit Support Balance you are holding comprises of illiquid pref shares listed on the Manila bourse, while the CSA prescribes only G7 on-the-run government securities, then guess what.
Initial margin
For reasons best known to themselves there are curious rules in the US relating to initial margin which lead counterparties to use different ISDA CSA forms on different occasions. The details and variegation at play here — are you an SBSD counterparty? Are you subject to EMIR too? Is the AANA threshold met? — are all too ghastly for the JC to presently get into, other than to say the tiny peripheral benefits you get from gaming the fractal edges of the system of rules are most likely not worth it and it is probably better to have a single, maximally conservative, theory of the game: all that being well and good, of course, if your counterparties have a different view of the world, or a different idea what is the maximally conservative theory of the game.
This is what happens if you try to standardise and centralise a market that was designed to be unstandardised and decentralised, but still.
The dark side of margin
On the subject of pained exegeses which no-one will heed, the JC also has an impassioned essay about why bilateral variation margin may have a destabilising effect on the broader financial system, potentially weakening swap dealers’ liquidity and risk positions — a risk which was admirably demonstrated during the Archegos fiasco.
But no-one listens to the JC, so you should treat this as extended universe fan fiction only.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays
- CFTC rules on eligiblity of collateral
- “Major currencies”, including a gratuitous dig at flightless birds
- Why reg VM is always “cashy” but reg IM is always uncashy.
See also
- Latham’s heroic yet, at the same time, faintly horrifying tabular comparison of US and UK margin rules.
- Katten’s equally distressing Initial Guidance for US Swap End Users which will surely have you clawing at your eyeballs even if Latham’s hasn’t already
- Our own house view: When variation margin attacks
- Archegos