Template:ISDA transaction and collateral flows

Transaction flows and collateral flows

In a fully margined ISDA Master Agreement, all other things being equal, the termination of a Transaction will lead to two equal and opposite effects:

• A final payment or exchange under the Transaction having a value more or less equal to the mark-to-market value of that Transaction;
• A offsetting change in the Exposure under the CSA in exactly the same value.

The strict sequence of these payments ought to be that the Transaction termination payment goes first, and the collateral payment follows.

Though that’s an odd outcome, as it means they paying party is knowingly increasing its Exposure to the counterparty for the couple of days it will take for that collateral return to find its way back. What with the regulators’ obsession on forcing parties to minimise their risk to each other, wouldn’t it be better to apply some kind of set off in anticipation?

You’d think so, but as of the time of writing, this doesn’t happen in practice. Transaction flows and collateral flows tend to be handled by different operational parts of an institution, and systems don’t talk.

Anyway, currently, the payer of a terminating transaction has its heart in its mouth for a day or so.