Preamble - VM CSA Provision
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ISDA 2016 English Law VM Credit Support Annex
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Overview
The main difference is that the 1995 CSA and the 2016 VM CSA each claim to be a “Transaction” under the ISDA Master Agreement, while the 1994 NY CSA, 2016 NY VM CSA and 2018 English law IM CSD do not, because it is not, for reasons we explain below.
Summary
Behold, the theory of the ISDA. There is this framework agreement, the ISDA Master Agreement, that provides the superstructure under which two parties may execute swap “Transactions” but until they have executed swap Transactions, which they will do under a Confirmation, then no gears are engaged and the ISDA Master Agreement does nothing. It is merely a relationship contract.
This dynamic changes upon default: on close-out all the Transaction values are totted up, netted down, and a single Early Termination Amount becomes payable not under those now defunct Transactions — they have been wiped away — but under the single agreement itself.
In the meantime, the credit support arrangement is designed to mitigate the frightful risks the parties present to each other by obliging them regularly to cash up their net exposures to each other. The “credit support” they post offsets, as closely as possible, what the out-of-the-money party would owe were the ISDA closed out and all Transactions terminated each day.
Now, English lawyers like to collateralise by title transfer, and Americans by pledge. We do not know exactly why this is: it seems to be a matter of tradition and market practice. This leads to some profound conceptual differences between the forms of CSA, even if the practical differences are minimal.
Since collateral passes under a English law CSAs by title transfer, it is not a security arrangement as such: rather, the parties agree to transfer collateral to each other outright, with no expectations beyond the recipient’s conditional obligation to return something economically equivalent when trading circumstances require it. This return obligation is a debt claim against the recipient and not any kind of bailment or custody arrangement.
Indeed, it resembles an odd, highly personalised swap Transaction. And, sure enough, English law CSAs are treated as “Transactions” and not “Credit Support Documents” under the ISDA Master Agreement. Their effectiveness as a credit support device depends on close-out netting of the CSA Transaction against the net value of all the other Transactions under the Agreement.
Because they are traditional security arrangements, the New York law CSAs (and the English law English law CSD) are “Credit Support Documents” but are not “Transactions” under the ISDA Master Agreement.
So a English law CSA, works by eliminating the out-of-the-money’s indebtedness by creating an equal offsetting indebtedness. A New York law CSA by granting a traditional security interest for the indebtedness, but not otherwise affecting it.
This is magical, bamboozling stuff — deep ISDA lore — and, at least where rehypothecation is allowed — it pretty much always is — it makes no real difference, because from the moment of reuse, the pledgor has only credit claim for return of assets.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays