Return Amount - CSA Provision
1995 ISDA Credit Support Annex (English Law)
Paragraph 2(b) in a Nutshell™
Use at your own risk, campers!
Full text of Paragraph 2(b)
Related agreements and comparisons
Content and comparisons
The only differences here are the liberal, but all the same redundant, spraying of “(VM)” all over the shop in the 2016, a single reference to the Regular Settlement Day in place of non-Regular — that is to say, regular — Settlement Day (which goes pretty much without saying anyway, per our nutshell version) and the fact that the balance is deducted from the Credit Support Balance in the 1995, but the Transferee’s Exposure in the 2016 (there not being a concept of a Credit Support Amount in the 2016), for reasons which are explored more fully below).
Calculating Delivery Amounts and Return Amounts
Differences between 1995 English Law CSA and 2016 English law VM CSA
Note that under a 2016 English law VM CSA there is no Independent Amount or Threshold, so there is no need for a Credit Support Amount (which is Exposure adjusted by applicable Independent Amounts and Thresholds) — everything keys off the plain old Exposure.
Unless, that is, you have retrofitted your 2016 English law VM CSA to include Independent Amounts. The below assumes you have done that. Because some genius in your credit department will have decided this is really important. If you haven’t, it is a bit easier: just substitute “Credit Support Amount” for “Exposure”. For more on this stimulating topic, see Credit Support Amount (VM/IA).
First: work out your Credit Support Amount. This is:
- Transferee’s Exposure + Net Independent Amounts (IF ANY)
Second: calculate the Value of the Transferor’s Credit Support Balance. This is basically the prevailing value of the Eligible Credit Support (and income on it) that the Transferor has ponied up at that time.
Third: Deduct the Credit Support Balance from the Credit Support Amount. Fourth: If the difference from the sum you did in (3):
- is less than zero, KEEP QUIET. If you are lucky, the other guy won’t ask you for a Return Amount.
- is more than zero but less than the Minimum Transfer Amount, also KEEP QUIET. No Delivery Amount for you today, because you haven’t exceeded the Minimum Transfer Amount, so you are not entitled to one.
- is more than the Minimum Transfer Amount you can demand the whole amount (I.e., not just the bit over the MTA).
Basically the converse of a Delivery Amount. In this case you deduct the Credit Support Amount from the Credit Support Balance.
What about in-flight Credit Support deliveries?
So yesterday you met a margin call by delivering a bond the standard settlement cycle for which means it won’t arrive till the day after tomorrow. How is this “in-flight collateral” treated for the purpose of today’s margin call? It’s treated as if you have already made it. This is the significance of the parenthetical:
“(adjusted to include any prior Delivery Amount and to exclude any prior Return Amount, the transfer of which, in either case, has not yet been completed and for which the relevant Settlement Day falls on or after such Valuation Date).”
However, if your counterparty fails in the meantime (before the bond has settled, and assuming ultimately it never does), it would count as an Unpaid Amount which would factor into your close-out calculation.
At first blush, this seems an odd result, but the risk is a time value risk associated with the collateral, not a counterparty risk per se. You accepted it when you agreed to Eligible Credit Support with a long a settlement cycle in the first place. If you don’t want that time-value risk, don’t agree to collateral with a long settlement cycle.
Bonus learning for free: In arithmetic, a sum being subtracted is the “subtrahend” and the sum it is being subtracted from is the “minuend”.
Timing of transfers under a CSA
This is how the timing works for CSA transfers. Remember the Valuation Agent is simply the person making the demand. Terminology check: to make this easy we refer to both Delivery Amounts and Return Amounts as “Transfer Amounts”. The date on which someone actually demands a Transfer Amount we call a “Demand Date”.
Valuation of Exposure and Credit Support Balance: Firstly, you must value what you are going to call, which will be the Transfer Amount under para 2(a) or 2(b). This is roughly Credit Support Balance - Exposure (or vice versa).
Per para 2(a) the Transferor will transfer Eligible Credit Support having a Value equal to the Transfer Amount as of the date of transfer. Under the Calculations provision all calculations happen at the relevant Valuation Time. Fluctuations in value after that time won’t invalidate the Transfer Amount, but they may mean a party can immediately call for more Credit Support (that is, have another Demand Date). The Valuation Time in turn keys off the Valuation Date.
Demand Date: On any date that is (or promptly follows) a Valuation Date in which the Exposure has moved in its favour, one party may demand a Delivery Amount or a Return Amount.
Transfer Date: Under para 3(a) (Transfers) if the Demand Date is a Local Business Day and demand is received before the Notification Time, the transfer must be made not later than close of business on the related Regular Settlement Day. If received after the Notification Time (or at any time on a non-Local Business Day), the transfer must be made by close of business on the Regular Settlement Day relating to the day after the Demand Date.
Settlement Day: Here is where things differ materially between the 1995 English Law CSA and the 2016 English law VM CSA.
1995 English Law CSA: The Settlement Day for any day (whether or not it is a Local Business Day) is:
- Cash: for cash, the next Local Business Day and,
- Securities: for securities, the Local Business Day after the date on which a trade in the relevant security, if effected on the day in question, would have been settled in accordance with customary practice.
2016 English law VM CSA: In the new world we have the new concept of the Regular Settlement Day, and this is the same Local Business Day as the Demand Date. The run-off text at the end of Paragraph 3(a) gives you a little more flex: if the demand came after the Notification Time, then you must make the transfer by close on the Regular Settlement Day for the next day.
Demand Date not a Local Business Day: What if the Demand Date is not a Local Business Day? E.g., what if it is received after the Notification Time on a Friday, meaning the Settlement Day takes place on the date on which a trade, effected on a Saturday, would have been settled in accordance with customary practice?
- Securities: For securities this is ok: a trade effected on a non-business day would be deemed to be effected on the next following Local Business Day anyway, so it would pick this up.
- Cash: For cash, not so clear.
What happens if the transferred credit support changes in value on the Settlement Day?
What happens to Exposures if the Settlement Day is a long time after the Demand Date? Is the demand, if answered with irrevocable instructions to deliver, treated as having been met, or does the Exposure stay outstanding until the collateral actually comes in? The answer (counterintuitive, given that the Transferee remains subject to the credit exposure during this time) is YES, thanks to the definitions of Delivery Amount and Return Amount, both of which include the words:
“...the Value as of that Valuation Date of the Transferor’s Credit Support Balance (adjusted to include any prior Delivery Amount and to exclude any prior Return Amount, the transfer of which, in either case, has not yet been completed and for which the relevant Settlement Day falls on or after such Valuation Date).”
What if I have to pay out a Transaction termination amount which the counterparty is already holding all or some of by way of variation margin? Since it will owe me that back, we can just off set those and call it quits, right? Wrong. See our separate article on that issue.
1995 ISDA CSA
Under a 1995 ISDA CSA the Credit Support Amount is the total amount one counterparty must have delivered to the other at any time: the combination of the Exposure to that party and the net Independent Amounts it must post, minus any agreed Threshold.
No equivalent in the 2016 ISDA VM CSA
There is no concept of a Credit Support Amount in the 2016 ISDA VM CSA because the Credit Support Amount a party may require is no more than its Exposure to the other party — as already defined in the 2016 English law VM CSA. In the old 1995 English Law CSA one had to consider any pertinent Independent Amounts and the agreed Threshold.
No Independent Amounts
Life is much simpler in the world of regulatory variation margin for which the 2016 ISDA VM CSA is designed. Its only concern is variation margin. That is, there are no Independent Amounts. In the old 1995 English Law CSA, Independent Amounts were there to protect counterparties against potential swings in Exposure that might happen before the next margin call: that is, they are a buffer against the risk of market moves.
But in the old world, Independent Amounts were transferred outright to the Transferee, by title transfer. This created a conceptual issue for regulators, who were trying to minimise credit exposure between the parties: a title transfer of collateral to cover an Exposure that doesn’t yet — and might never — exist creates a negative exposure, because the holder of an Independent Amount would be indebted to the Transferor for its return.
All that said, there is a custom-built addition in Paragraph 11 that lets you build an Independent Amount concept back in if you really want one. And who, in their right chicken-lickeny mind, wouldn’t?
No Threshold either
And what about the Threshold? Well, there shouldn’t be one of those either: The thrust of the margin reforms in the different jurisdictions was to require counterparties to collateralise their total mark-to-market exposure, not just most of it, so in a rush of uncharacteristic blood to the head, ISDA did away with the concept altogether. There is usually some flex in the regulations, and don’t be surprised to see your more tempestuous counterparties hotly insisting on a Threshold, even just a nominal one.
So the Credit Support Amount vanishes, in a puff of logic and existential redundancy.
- ↑ In the 2016 ISDA VM CSA there really shouldn’t be IA as it kind of defeats the regulatory goal of marking actual exposures to market, but there may be, since ISDA caved and retrofitted the 2016 ISDA VM CSA with a an Independent Amount section
- ↑ Under the 1995 English Law CSA you may specify either close of business on the Valuation Date or the Local Business Day immediately before it. Under the 2016 English law VM CSA you have flexibility to determine the Valuation Time as at the point you your book each day.
- ↑ It need not be a Local Business Day.
- ↑ Under para 2(a).
- ↑ Under para 2(b).
- ↑ The “Settlement Day” under the 1995 English Law CSA is slightly different.
- ↑ Note: ordinary day, not Local Business Day
- ↑ Just how the business days interact under the ISDA and CSA is about as complicated as string theory, by the way. For a cheat’s guide, see How business days work under the CSA. You’re welcome!
- ↑ As it may well be, under a 1995 English Law CSA, if the collateral is corporate bonds held in a clearing system
- ↑ Well, alright, should be no Independent Amounts.
- ↑ Under Engliush law CSAs, at any rate. But the effect was the same where rehypothecation was allowed under a 1994 ISDA CSA (NY law) too.
- ↑ Hence, regulatory initial margin cannot be cash, and must be pledged and not title transferred.
- ↑ For more information see Credit Support Amount (VM/IA).