Independent Amount - CSA Provision
1995 ISDA Credit Support Annex (English Law)
Paragraph Independent Amount in full
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Perhaps you are seeking enlightenment about the 2018 English law IM CSD? If so, brave chicklings, there is a nascent anatomy of it here, and while there is not yet a lot in it — the JC has been assiduously avoiding the topic of regulatory initial margin, as, what with lockdown, he fears it might push him over the edge — the JC has peeked over the rim a couple of times, and as a result it has quite a lot about the Margin Approach and related things, which is where that dismal document is at its most radically dismal.
Anyhow, the only difference between the 1994 ISDA CSA (NY law) and the 1995 ISDA CSA is the reference to Base Currency Equivalent — maybe the Americans just assumed everything would be done in USD. There is no equivalent definition in the regulatory VM versions published in 2016, since they deal only with variation margin and not initial margin, though you will see if you follow what should be a broken link, there is a way of reverse-engineering an IM component back into a reg VM 1995 English Law CSA with some fancy footwork in the elections paragraph.
To be contrasted with variation margin, initial margin (in the ISDA troposphere known as an “Independent Amount”) is the amount of margin you hold in excess of current mark-to-market exposure. You hold it to cover the risk that the market moves suddenly against your counterparty at the same time as it implodes, all before you have a chance to make a further variation margin call.
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 as written in the 1995 English Law CSA looks like a fixed currency amount that is paid at the beginning of a relationship, irrespective of how many Transactions you may have on — 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 1995 English Law CSA doesn’t have a concept of “initial margin”, and 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.
In any case, what the market has done since the Children of the Forest 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”, 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 IA 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 1995 English Law CSA’s ordinary Transfer provisions.
Calculating your 1995 English Law CSA
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)].
- 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.
- 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.