Interest Payment (VM) - VM CSA Provision

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2016 ISDA Credit Support Annex (VM) (English law)
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Paragraph 5(c)(ii) in a Nutshell™

Use at your own risk, campers!
5(c)(ii) Interest Payment (VM). Subject to Paragraph 11(g)(iv):
5(c)(ii)(A) if “Interest Transfer” applies the Interest Payer (VM) must transfer an Interest Payment (VM) to the Interest Payee (VM), as required under Paragraph 11(g)(ii) and on any Early Termination Date provided that if “Interest Payment Netting” applies:
(I) if the Interest Payer (VM) is due a payment under the VM CSA on the same date:
(a) it will be reduced by the Interest Payment (VM) (but not below zero), provided that for a Return Amount (VM), the deduction will only apply to the extent of any Base Currency cash portion of the Credit Support Balance (VM); and
(b) after any such reduction the Interest Payer (VM) must transfer the remaining Interest Payment (VM) to the Interest Payee (VM);
(II) following such a reduction, when working out the Credit Support Balance (VM), the Transferee will be deemed to have received or transferred the Base Currency cash equivalent of the reduced amount, on the due date for the Interest Payment (VM); and
5(c)(ii)(B) if “Interest Adjustment” applies the Credit Support Balance (VM) will be adjusted by the Transferee, as required under Paragraph 11(g)(ii) and on any Early Termination Date, as follows:
(I) if the Interest Amount (VM) is positive, it will be added in the Base Currency to the Credit Support Balance (VM); and
(II) if the Interest Amount (VM) is negative, its absolute value in the Base Currency will be deducted from the Credit Support Balance (VM), provided that if the Base Currency cash portion of the Credit Support Balance (VM) is less than that absolute value, the reduction will be limited to that Base Currency cash and the Transferor must transfer the remainder to the Transferee on the due date.

Full text of Paragraph 5(c)(ii)

5(c)(ii) Interest Payment (VM). Unless otherwise specified in Paragraph 11(g)(iv):
5(c)(ii)(A) if “Interest Transfer” is specified as applicable in Paragraph 11(g)(ii), the Interest Payer (VM) will transfer to the Interest Payee (VM), at the times specified in Paragraph 11(g)(ii) and on any Early Termination Date referred to in Paragraph 6, the relevant Interest Payment (VM), provided that if “Interest Payment Netting” is specified as applicable in Paragraph 11(g)(ii):
(I) if the Interest Payer (VM) is entitled to demand a Delivery Amount (VM) or Return Amount (VM) in respect of the date such Interest Payment (VM) is required to be transferred:
(a) such Delivery Amount (VM) or Return Amount (VM) will be reduced (but not below zero) by the Interest Payment (VM), provided that, in case of such Return Amount (VM), if the amount in the Credit Support Balance (VM) which is comprised of cash in the Base Currency is less than such Interest Payment (VM), such reduction will only be to the extent of the amount of such cash comprised in the Credit Support Balance (VM) (the “Eligible Return Amount (VM)”); and
(b) the Interest Payer (VM) will transfer to the Interest Payee (VM) the amount of the excess, if any, of such Interest Payment (VM) over such Delivery Amount (VM) or Eligible Return Amount (VM), as applicable;
(II) if under Paragraph 5(c)(ii)(A)(I)(a) a Delivery Amount (VM) is reduced (the amount of such reduction, the “Delivery Amount Reduction (VM)”) or a Return Amount (VM) is reduced (the amount of such reduction, the “Return Amount Reduction (VM)”), then for purposes of calculating the Credit Support Balance (VM) only, the Transferee will be deemed to have received an amount in cash in the Base Currency equal to any Delivery Amount Reduction (VM) and will be deemed to have transferred an amount in cash in the Base Currency equal to any Return Amount Reduction (VM), as applicable, in each case on the day on which the relevant Interest Payment (VM) was due to be transferred; and
5(c)(ii)(B) if “Interest Adjustment” is specified as applicable in Paragraph 11(g)(ii), the Credit Support Balance (VM) will be adjusted by the Transferee, at the times specified in Paragraph 11(g)(ii) and on any Early Termination Date referred to in Paragraph 6 as follows:
(I) if the Interest Amount (VM) for an Interest Period is a positive number, the Interest Amount (VM) will constitute an addition of an amount of cash in the Base Currency comprised in the Credit Support Balance (VM); and
(II) if the Interest Amount (VM) for an Interest Period is a negative number, the Interest Amount (VM) will constitute a reduction to the amount of cash in the Base Currency comprised in the Credit Support Balance (VM) in an amount (such amount, the “Interest Adjustment Reduction Amount (VM)”) equal to the absolute value of the Interest Amount (VM); provided that if the amount in the Credit Support Balance (VM) which is comprised of cash in the Base Currency is less than the Interest Adjustment Reduction Amount (VM), such reduction will only be to the extent of the amount of such cash comprised in the Credit Support Balance (VM) and the Transferor will be obliged to transfer the remainder of the Interest Adjustment Reduction Amount (VM) to the Transferee on the day that such reduction occurred.


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Content and comparisons

Coming at you live and direct from the I’m sorry I asked file. ISDA’s crack drafting squad™ takes a fairly straightforward concept under the 1995 CSA and — well: see for yourself.

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Summary

Interest Amounts under the 1995 CSA

It really ought to be quite simple, and in the 1995 CSA it is: if a Transferor has posted cash — probably less likely back in the day, but in the world of regulatory margin, de rigueur nowadays — then you get interest on it — as long as paying interest wouldn’t, in itself, trigger a call for a further Delivery Amount by the Transferor — thus precipitating a (short) game of operational ping-pong between the two parties’ back office teams.

How would that happen? All other things staying equal, it couldn’t: if the Transferee’s Exposure and the Value of the Transferor’s Credit Support Balance stayed the same as it was when variation margin was last called, the arrival of interest on any part of that Credit Support Balance increases its value and, since it was calibrated to equal an exposure exactly, ought to be spirited back to the Transferor: the Transferee otherwise would become indebted for the value of that interest to the Transferor, which for variation margin is not the idea.

But as we know, Exposures don’t just quietly sit there. If they did, there wouldn’t be any need for initial margin, and collecting even variation margin would be less fraught. So if the Transferee’s Exposure has increased, the arrival of that interest might serve to fill a hole in the existing coverage, in which case, why pay it away only to ask for it back again?

Interest Amounts under the 2016 VM CSA

But in the 2016 VM CSA things get a little more complex. There follows an excruciating torture session for innocent and well-loved members of her majesty’s vocabulary, and all to get across a simple point. In the nutshell to the right I have tried to simplify the drafting but I am a bit jet-lagged and it is testing even my patience. But know this: Interest Payment is a fiddly, time-and resource-consuming pain which will inevitably lead to error, confusion and name-calling. Interest Adjustment — just adding accrued interest to your Credit Support Balance — is far simpler and more elegant: none of this Kafkaesque complexities for netting and offsetting individual payments. It all comes out in the wash.

First, you have the choice between “Interest Transfer” and “Interest Adjustment”.

Interest Transfer

Here there is the choice of whether “Interest Payment Netting” applies. As far as the JC can tell, most market participants have switched this off, we surmise simply to avoid the torture of figuring out what you have to pay if it is switched on.

If Interest Payment Netting does not apply, then the Interest Payer must pay interest per the agreement in the elections (at Paragraph 11(g)(ii)), and note there is no proviso allowing you to cry off if paying this amount would create a new Delivery Amount.

If Interest Payment Netting does apply then descend we must into the labyrinthine mind of ISDA’s crack drafting squad™. The short point is that you must work out if, on the same date, the Interest Payer is due a cash payment under the 2016 VM CSA, and if so, net the two off and pay the balance. Again, no proviso for what happens if this payment would lead to a margin call from the Interest Payer.

Interest Adjustment

Interest Adjustment is a far simpler method: incoming interest is just added to the Credit Support Balance. If, on your next margin call, net, the Credit Support Balance exceeds your counterparty’s Exposure to you, you get your interest back through the normal mechanism of calling for a Return Amount. All the netting and offsetting happens automatically. The only contingency — and well spotted, ISDA’s crack drafting squad™, for this one is truly for details freaks — is if you receive negative interest on your Credit Support Balance such that it wipes out the Credit Support Balance entirely and is still unsatisfied, then the Interest Payer — and in the case of negative interest, this is the person Transferor, not the Transferee — has to pay the balance. But if you are accruing interest and calling for margin daily, the likelihood of that happening is extremely low, and it is hard to see why you couldn’t just add this to the usual margin call process as well (since it is likely to be a daily process).

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General discussion

Template:M gen 2016 CSA 5(c)(ii)

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See also

Template:M sa 2016 CSA 5(c)(ii)

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References

ISDA 2016 English Law VM Credit Support Annex

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Interest Payment in a Nutshell™

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Original text:

5(c)(ii) Interest Payment (VM). Unless otherwise specified in Paragraph 11(g)(iv):
5(c)(ii)(A) if “Interest Transfer” is specified as applicable in Paragraph 11(g)(ii), the Interest Payer (VM) will transfer to the Interest Payee (VM), at the times specified in Paragraph 11(g)(ii) and on any Early Termination Date referred to in Paragraph 6, the relevant Interest Payment (VM), provided that if “Interest Payment Netting” is specified as applicable in Paragraph 11(g)(ii):
(I) if the Interest Payer (VM) is entitled to demand a Delivery Amount (VM) or Return Amount (VM) in respect of the date such Interest Payment (VM) is required to be transferred:
(a) such Delivery Amount (VM) or Return Amount (VM) will be reduced (but not below zero) by the Interest Payment (VM), provided that, in case of such Return Amount (VM), if the amount in the Credit Support Balance (VM) which is comprised of cash in the Base Currency is less than such Interest Payment (VM), such reduction will only be to the extent of the amount of such cash comprised in the Credit Support Balance (VM) (the “Eligible Return Amount (VM)”); and
(b) the Interest Payer (VM) will transfer to the Interest Payee (VM) the amount of the excess, if any, of such Interest Payment (VM) over such Delivery Amount (VM) or Eligible Return Amount (VM), as applicable;
(II) if under Paragraph 5(c)(ii)(A)(I)(a) a Delivery Amount (VM) is reduced (the amount of such reduction, the “Delivery Amount Reduction (VM)”) or a Return Amount (VM) is reduced (the amount of such reduction, the “Return Amount Reduction (VM)”), then for purposes of calculating the Credit Support Balance (VM) only, the Transferee will be deemed to have received an amount in cash in the Base Currency equal to any Delivery Amount Reduction (VM) and will be deemed to have transferred an amount in cash in the Base Currency equal to any Return Amount Reduction (VM), as applicable, in each case on the day on which the relevant Interest Payment (VM) was due to be transferred; and
5(c)(ii)(B) if “Interest Adjustment” is specified as applicable in Paragraph 11(g)(ii), the Credit Support Balance (VM) will be adjusted by the Transferee, at the times specified in Paragraph 11(g)(ii) and on any Early Termination Date referred to in Paragraph 6 as follows:
(I) if the Interest Amount (VM) for an Interest Period is a positive number, the Interest Amount (VM) will constitute an addition of an amount of cash in the Base Currency comprised in the Credit Support Balance (VM); and
(II) if the Interest Amount (VM) for an Interest Period is a negative number, the Interest Amount (VM) will constitute a reduction to the amount of cash in the Base Currency comprised in the Credit Support Balance (VM) in an amount (such amount, the “Interest Adjustment Reduction Amount (VM)”) equal to the absolute value of the Interest Amount (VM); provided that if the amount in the Credit Support Balance (VM) which is comprised of cash in the Base Currency is less than the Interest Adjustment Reduction Amount (VM), such reduction will only be to the extent of the amount of such cash comprised in the Credit Support Balance (VM) and the Transferor will be obliged to transfer the remainder of the Interest Adjustment Reduction Amount (VM) to the Transferee on the day that such reduction occurred.

The varieties of ISDA CSA
Subject 1994 NY 1995 Eng 2016 VM NY 2016 VM Eng 2018 IM Eng
Preamble Pre Pre Pre Pre Pre
Interpretation 1 1 1 1 1
Security Interest 2 - 2 - 2
Credit Support Obligations 3 2 3 2 3
Transfers, Calculations and Exchanges - 3 - 3 -
Conditions Precedent, Transfer Timing, Calculations and Substitutions 4 - 4 - 4
Dispute Resolution 5 4 5 4 5
Holding and Using Posted Collateral 6 - 6 - 6
Transfer of Title, No Security Interest - 5 - 5 -
Events of Default 7 6 7 6 7
Rights and Remedies 8 - 8 - 8
Representations 9 7 9 7 9
Expenses 10 8 10 8 10
Miscellaneous 11 9 11 9 11
Definitions 12 10 12 10 12
Elections and Variables 13 11 13 11 13

Resources and Navigation

Index: Click ᐅ to expand:
1994 NY CSA
1995 CSA
2016 VM CSA

Overview

Some development from the OG to the 2016 ISDA VM CSA that came about when ISDA’s crack drafting squad™, bless them, contrived in Para 5(c)(ii) to design an option no-one in their right mind would have wanted, namely to choose between Interest Transfer — in which you can have interest that accrues on your Credit Support Balance periodically paid to you — or Interest Amount, in which interest accruals are just capitalised and added to the Credit Support Balance, effectively folding all that into the weft and warp of daily transfers that you will be making anyway.

Summary

To be fair to them, the OG only contemplated transfer of accrued interest, which in the context of a modern, daily margined swap business, is barking mad, so at least having the option to just capitalise interest is better than not having it.

But better still would be just straight out capitalising interest, with no option to transfer it. Perhaps this is just me.

Interest Amounts under the 1995 CSA

It really ought to be quite simple, and in the 1995 CSA it is: if a Transferor has posted cash — probably less likely back in the day, but in the world of regulatory margin, de rigueur nowadays — then you get interest on it — as long as paying interest wouldn’t, in itself, trigger a call for a further Delivery Amount by the Transferor — thus precipitating a (short) game of operational ping-pong between the two parties’ back office teams.

How would that happen? All other things staying equal, it couldn’t: if the Transferee’s Exposure and the Value of the Transferor’s Credit Support Balance stayed the same as it was when variation margin was last called, the arrival of interest on any part of that Credit Support Balance increases its value and, since it was calibrated to equal an exposure exactly, ought to be spirited back to the Transferor: the Transferee otherwise would become indebted for the value of that interest to the Transferor, which for variation margin is not the idea.

But as we know, Exposures don’t just quietly sit there. If they did, there wouldn’t be any need for initial margin, and collecting even variation margin would be less fraught. So if the Transferee’s Exposure has increased, the arrival of that interest might serve to fill a hole in the existing coverage, in which case, why pay it away only to ask for it back again?

Interest Amounts under the 2016 VM CSA

But in the 2016 VM CSA things get a little more complex. There follows an excruciating torture session for innocent and well-loved members of Her Majesty’s vocabulary, and all to get across a simple point. In the premium content nutshell JC has tried to simplify the drafting but I am a bit jet-lagged and it is testing even my patience. But know this: Interest Payment is a fiddly, time-and resource-consuming pain which will inevitably lead to error, confusion and name-calling. Interest Adjustment — just adding accrued interest to your Credit Support Balance — is far simpler and more elegant: none of this Kafkaesque complexity for netting and offsetting individual payments. It all comes out in the wash.

When you might want Interest Payment

Now there is a “use-case” for the Interest Payment method — it’s pretty niche, though — which we will talk about over at the premium JC.

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  • The niche, but not altogether sensible, case for Interest Payment on hedging instrument to a syndicated loan.

See also

References

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