Independent Amount - CSA Provision
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Discussion
Variation margin, or “VM”, is a credit mitigation technique designed to minimise the credit risk parties have to each other under bilateral derivative transactions. It requires the counterparties give each other collateral — typically cash — each day to ensure that their net collateralised exposure is effectively nil. For example, if the net “replacement cost” of the swaps between two counterparties on a given day is $10 million, the “out-of-the-money” party, who would have to pay it were all the transactions terminated, has to pay the “in-the-money” counterparty $10 million in cash (subject to agreed Thresholds and Minimum Transfer Amounts). This happens every day; variation margin can be paid either way, depending on how the net portfolio moves. Volatile markets can quickly move — a day is a long time when black swans are on the wing — so parties often want a little something extra to tide them over for expected movements between now and the next variation margin payment date. For that, you need initial margin.
If you look at it cold, this looks like a fixed currency amount that is paid at the beginning of a relationship, irrespective of how many Transactions you may have on. But it will be often defined as “an amount agreed between the parties or as otherwise advised by Party X”, which rather kicks the issue in to touch. In practice, it’s likely to be articulated as a multiplier on notional, and will be payable at the start of each Transaction, and may be adjusted on the fly.
Particularly where underlying trades and markets are volatile, expect to see a lot of customisation here.
- The independent amount might be calculated by reference to a given multiplier for a given asset (or type of assets - it is not uncommon to see tiering in FX transactions, for example, where Transactions on currencies in the highest Tier might have a low (say 2%) multiplier, and Transactions on currencies in the lowest Tier might carry a a 100% multiplier).
- 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 elgible 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 ordinary Transfer provisions.
See also
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