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This is going to be quite the epistolic journey. Like a Dickens novel designed for people with no taste in literature and an unusually high threshold for pain. I have started to refresh the CSA pages. As I go I am going to put out newsletters and podcasts. Here is the first once.

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The preamble to ISDA’s CSA

On preambles, weapons in Russian plays, etc.

The “preamble” is the throat-clearing passage of a commercial legal document: the scene-setter that puts you in the right place, the right frame of mind, and gives you a non-spoiling sense of what is coming. It is the warm-up question on Millionaire, designed to settle an anxious contestant down, so you might expect there to be little more to say about it.

Now occasionally a preamble might introduce a key fact into the narrative — a kind of “Chekhov’s gun” that the reader must mark, bear in mind, make mental note of, and prepare for its discharge in the third act.

The preamble to ISDA’s suite of Credit Support Annexes is no exception. There are not one, but now seven: the first was released to the Americans in 1994, a couple followed for the Brits in 1995, and four more came with the algal bloom of margin regulation in the latter half of the 2010s.

The different CSA varieties have different preambles casually mentioning different firing irons fixed to the wall over the fireplace. So what is all that about, then?

Credit Support Document or Transaction?

The 1994 NY law CSA declares itself to be:

...a Credit Support Document under this Agreement

while the 1995 English law CSA that followed hard on its heels reports that the credit support arrangements it documents:

...constitute a Transaction (for which this Annex constitutes the Confirmation).

Isn’t that odd? In the ISDA universe, “Transactions” and “Credit Support Documents” are mutually exclusive things: one is an integral exchance done under the ISDA Master Agreement, the other an independent covenant that stands apart from the Aïessdiyé. Can the ’Squad, in their Wording, have meant them to be different?[1]

Well, roll forward a brace of decades and see what has changed. It is the post-apocalyptic year of our lord 2016. The kind warm glow of ISDA watches over the planet’s “safe, effcient markets”. The CSA form has been updated for the new regulatory world — but the, hark! The same dissonance!

The 2016 English law VM CSA, too, is a “Transaction” while its American brother the 2016 ISDA VM NY CSA is still a “Credit Support Document”! This cannot be — and not is it — an accident.

Now, English lawyers like to collateralise by title transfer, and Americans by pledge. The reasons are deep and somewhat interesting — there are some essays about it in the premium content — but in any weather this leads to some profound conceptual differences between the forms of CSA, even if the practical differences are minimal.

Title transfer CSAs are Transactions

Since collateral passes under title transfer 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 for payment of an equivalent asset and not any kind of bailment, custody arrangement or ownership right in the asset originally posted.

Indeed, it resembles — is characterised as — an odd, highly personalised, self-referencing derivative Transaction.

Security interest CSAs are Credit Support Documents

Because they are traditional security arrangements, the security interest CSAs are characterised as “Credit Support Documents” and not “Transactions” under the ISDA Master Agreement.

So a title transfer CSA works by eliminating the out-of-the-money’s indebtedness by creating an equal offsetting indebtedness which may, if push really comes to shove, be netted down to mostly nothing.

A security interest CSA, by contrast, grants accepts some collateral and takes a traditional security interest over it as a surety for the indebtedness comprising that ISDA Exposure. That surety is a different covenant. It does not affect the quantum of the obligations under the ISDA: it comes into play only once they have not been honoured.

These are theoretical, and not practical differences. In practical fact, the arrangements are identical. Still, this is magical, bamboozling stuff — deep ISDA lore — even though, at least where rehypothecation is allowed — and it almost always is — it makes no real difference, to the parties whether the collateral is pledged or title-transferred, because from the moment it is reused, the pledgor has only a “credit claim” against the secured party for its return.

Credit support generally

Credit support is designed to mitigate the frightful credit risks the parties present to each other by obliging them regularly to “cash up” their net Exposure.

It should go without saying, but let’s say it: at any time, on a net basis, only one party can have an Exposure to the other. What with Independent Amounts — more of a vogue back in the 1990s in the ancient CSAs, more frowned on in the regulatory VM world of the mid 21st century — you could have both parties holding the other’s collateral, but variation margin, reflecting the actual mark-to-market value of actual transactions, could only be pointing in one direction at a time.

“Credit support” transferred under a CSA is designed to offset, as closely as possible, the value of that overall “Exposure”: what the “out-of-the-money” party would owe the in-the-money party were all Transactions terminated and the ISDA closed out on any given day.

The differences betwixt, and the impact of, regulatory margin

Thanks to the global financial crisis and the subsequent move towards regulatory margin there are now, as I mentioned, six theoretically “live” versions of the CSA. They are as follows:

The 1994 and 1995 versions may still kick around in name, but will have been heavily modified to comply with Reg Margin requirements. The main ones are the 2018 Regulatory VM CSAs — these tend now to be cash-only, zero-threshold, single-currency affairs. The Regulatory IM CSAs are a fact of life, if your portfolio is big enough to be in scope, but these are generally less operationally troublesome, though structurally complex. Most of the JC coverage will focus on the variation margin CSAs, therefore.

Prime brokerage

There is one corner of the market where CSA arrangements still differ a bit, and that is the Prime Brokerage world, where a customer will have a margin loan arrangement, stock lending, custody and cash accounts, and the broker will “net margin” the customer across its whole portfolio. There will still be VM CSAs, but they do quite a lot less lifting.

There is a whole different part of this wiki devoted to that business. See prime brokerage.

We will carry on with a deeper look at the theory and the practical differences below.

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