Exposure - CSA Provision
1995 ISDA Credit Support Annex (English Law)
Paragraph Exposure in full
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The total mark-to-market exposure under your ISDA Master Agreement on a given day, not counting anything posted by way of credit support. That is, Exposure omits the mark-to-market exposure of the Transaction comprising the 1995 English Law CSA itself, because that would entirely bugger things up: the MTM of an ISDA including the CSA is, of course, more or less zero.
Relevance of Section 6 to the peacetime operation of the 1995 English Law CSA
The calculation of Exposure under the 1995 English Law CSA is modelled on the Section 6(e)(ii) termination methodology following a Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.
This means you calculate the Exposure as:
This is interesting because, as of its Termination Date the Transaction may be no more, but until those final exchanges are settled the obligations they represent — “Unpaid Amounts” in the argot of Section 6(e) — still exist and are included in the calculation of the Exposure.
Now, on the day you are meant to make that final settlement, which when (ahem — if) settled, would reduce your Exposure, you will call for your Delivery Amount or Return Amount assuming it has not (yet) been paid. By the time the Credit Support adjustment has been settled, that final settlement will have happened, meaning the person who paid the adjustment will be out of pocket, and will need to call it back (using the same process).
Market Quotation and the 2002 ISDA
- Market Quotation? But I have a 2002 ISDA: Note the references to Market Quotation and other 1992 ISDA specific things. If you are under a 2002 ISDA, these should be corrected. Of you could sign up to the 2002 ISDA Master Agreement Protocol and that would do it for you. In the 2016 English law VM CSA, note bothversions of the ISDA Master Agreement, with their contrasting approaches to close-out valuation, are provided for in the alternative.
- Mid-market?: A slight cognitive dissonance: It talks about your 6(e)(ii) amount - which is generally your replacement cost, at your side of the market, but then goes on to say determined at the mid-market price...
Calculating your Credit Support Amount
Superficially things are quite different between the 1995 English Law CSA and the 2016 English law VM CSA, but this all boils down to the fact that the 2016 English law VM CSA is meant to be a zero-threshold, variation margin-only affair, so the concepts of Independent Amount and Threshold, both of which confuse the 1995 English Law CSA, aren’t there to get in the way. Unless you go and put them in anyway, as we shall see...
How the IA contributes to the Credit Support Amount — being the amount of credit support in total that one party must have given the other at any time under the 1995 English Law CSA can be mind-boggling.
It pans out for a Transferee like so:
- The Transferee’s Exposure: the net mark-to-market value the Transferor would owe the Transferee under all outstanding Transactions if they were closed out (not counting, of course, the 1995 English Law CSA itself). Call this ETee.
- The Transferor’s Independent Amount: The total Independent Amount Transferor must give the Transferee we will call IATor. You can add this to the Transferee’s Exposure, but then you must remember to deduct ...
- The Transferee’s Independent Amount: Any Independent Amount the Transferee has to pay the Transferor. Call this IATee. . Lastly don’t forget to take into account ...
- The Transferor’s Threshold: Any Threshold that applies to the Transferor being the Exposure it is allowed to represent before it has to post variation margin in the first place.
Let’s plug in some numbers. Say:
- The Transferee’s Exposure is 10,000,000
- The Transferor’s Independent Amount IATor is 2,000,000
- The Transferee’s Independent Amount IATee is 0
- The Transferor’s Threshold is 5,000,000
Your Credit Support Amount is therefore the greater of zero and 10,000,000 + 2,000,000 - 0 + 5,000,000) = 7,000,000.
Now, whether you have to pay anything or receive anything as a result — whether there is a Delivery Amount or a Return Amount, in other words — depends whether your Credit Support Amount is greater or smaller than your prevailing Credit Support Balance, by at least the Minimum Transfer Amount.
2016 English law VM CSA with no IA amendment
Since the 2016 English law VM CSA assumes there is no Independent Amounts and no Thresholds, it is quite a lot easier. It is just the Exposure. So much so, that there isn’t even a concept of the “Credit Support Amount” under the 2016 English law VM CSA, unless you have retrofitted one, and who in their right mind would do that?
You have, haven’t you. You’ve gone and co-opted the Credit Support Amount (VM/IA) concept in your Paragraph 11 elections. Yes you did. No, don’t blame your credit department; don’t say you were just following orders. You did it.
2016 English law VM CSA with a customised IA amendment
Never mind. Well, just for you, the formula is a sort of half-way house: Under this unholy bastardisation of a 2016 English law VM CSA, a Transferee’s Credit Support Amount will be: Max[0, (ETee + IATor - IATee)].
Transaction flows and collateral flows
- A final payment or exchange under the Transaction having a value more or less equal to the present value of that Transaction;
- A offsetting change in the Exposure under the CSA in exactly the same value.
The strict sequence of these payments ought to be that the Transaction termination payment goes first, and the collateral return follows, since it can only really be calculated and called once the termination payment has been made.
I know what you’re thinking. Hang on! that means the termination payer pays knowing this will increase its Exposure for the couple of days it will take for that collateral return to find its way back. That’s stupid!
What with the regulators’ obsession minimise systemic counterparty credit risk, wouldn’t it be better to apply some kind of settlement netting in anticipation, to keep the credit exposure down?
Now, dear reader, have you learned nothing? It might be better, but “better” is not how ISDA documentation rolls. The theory of the ISDA and CSA settlement flows puts the Transaction payment egg before the variation margin chicken so, at the moment, Transaction flows and collateral flows tend to be handled by different operations teams, and their systems don’t talk. Currently, the payer of a terminating transaction has its heart in its mouth for a day or so.
- As opposed to the amount required to be transferred on that day, considering the “Credit Support Balance” the Transferee already holds — that’s the Delivery Amount or Return Amount, as the case may be.
- There’s something faintly absurd both parties exchanging Independent Amounts by title transfer — they net off against each other — but that’s as may be. Stupider things have happened. SFTR disclosure, for example.