Credit Support Annex and Collateral Terms
Credit Support Annex and Collateral Terms
The Credit Support Annex (CSA) is an annex to the ISDA Master Agreement that governs collateral exchange between OTC derivatives counterparties. It specifies who posts collateral, when, in what form, and how disputes are resolved. Proper CSA structuring reduces counterparty credit risk while maintaining operational efficiency.
Definition and Key Concepts
CSA Types
| Type | Governing Law | Transfer Mechanism |
|---|---|---|
| 1994 NY CSA | New York | Title transfer |
| 1995 English CSA | English | Security interest |
| 2016 VM CSA | NY or English | Variation margin compliant |
| IM CSA | NY or English | Initial margin compliant |
Post-2016 regulations require bilateral margin for non-cleared derivatives, making VM and IM CSAs standard.
Key Terms
| Term | Definition |
|---|---|
| Threshold | Uncollateralized exposure allowed per party |
| Minimum Transfer Amount (MTA) | Smallest collateral transfer required |
| Independent Amount (IA) | Upfront collateral (similar to initial margin) |
| Eligible Collateral | Assets acceptable as margin |
| Haircut | Discount applied to collateral value |
| Valuation Date | Day exposure and collateral are calculated |
| Notification Time | Deadline for margin calls |
Exposure Calculation
Credit Support Amount formula: CSA = max(0, Exposure - Threshold - IA) + IA
Where:
- Exposure = net mark-to-market of all transactions
- Threshold = uncollateralized amount permitted
- IA = Independent Amount (if applicable)
How It Works in Practice
Daily Margin Process
Standard workflow:
| Time (NY) | Activity |
|---|---|
| 10:00 AM | Valuation Agent calculates exposure |
| 10:30 AM | Margin call issued (if above MTA) |
| 11:00 AM | Dispute window opens |
| 4:00 PM | Collateral transfer deadline |
| 6:00 PM | Confirmation of receipt |
Threshold and MTA Examples
| Counterparty Type | Typical Threshold | Typical MTA |
|---|---|---|
| AA-rated bank | $0 | $500,000 |
| A-rated bank | $10 million | $1 million |
| BBB-rated corporate | $5 million | $500,000 |
| Hedge fund | $0 | $250,000 |
| Pension fund | $25 million | $1 million |
Higher thresholds reduce operational burden but increase credit exposure.
Eligible Collateral Schedule
| Collateral Type | Haircut | Typical Eligibility |
|---|---|---|
| Cash (USD) | 0% | Always eligible |
| Cash (EUR, GBP) | 0% | Usually eligible |
| US Treasuries (< 1 year) | 0.5% | Commonly eligible |
| US Treasuries (1-5 years) | 2% | Commonly eligible |
| US Treasuries (> 10 years) | 4% | Sometimes eligible |
| Agency MBS | 4-8% | Sometimes eligible |
| Investment grade corporate | 10-15% | Rarely eligible |
| Equities | 15-25% | Rarely eligible |
Haircut Application
Example: Party posts $10 million face value 5-year Treasury (haircut = 2%)
Collateral value = $10,000,000 × (1 - 0.02) = $9,800,000
The receiving party credits $9.8 million toward margin requirement.
Worked Example
CSA terms:
- Threshold (Party A - Bank): $0
- Threshold (Party B - Fund): $0
- MTA: $500,000
- Eligible Collateral: Cash USD, US Treasuries
- Valuation Agent: Party A
- Haircut on Treasuries: 2%
Day 1 calculation:
- Total swap MTM: Party A owes Party B $15 million
- Party B exposure to Party A: $15 million
- Party B Threshold: $0
- Credit Support Amount from Party A: $15 million
Party A must post $15 million collateral to Party B.
Day 2 calculation:
- Total swap MTM: Party A owes Party B $12 million
- Previous collateral held by Party B: $15 million
- Excess collateral: $15 million - $12 million = $3 million
Party B must return $3 million to Party A.
Day 3 calculation (with MTA):
- Total swap MTM: Party A owes Party B $12.4 million
- Required collateral: $12.4 million
- Current collateral: $12 million
- Shortfall: $400,000
Since $400,000 < MTA ($500,000), no margin call is made.
Dispute Resolution
Day 4 scenario:
- Party A calculates MTM: $11 million
- Party B calculates MTM: $13 million
- Difference: $2 million
Resolution process:
- Parties exchange valuations
- Identify specific transactions causing difference
- If unresolved, obtain third-party quote
- Undisputed amount ($11 million) transferred pending resolution
- Disputed amount resolved within 5 business days
Risks, Limitations, and Tradeoffs
Collateral Risks
| Risk | Description | Mitigation |
|---|---|---|
| Wrong-way risk | Collateral value falls when needed most | Use cash or high-quality government bonds |
| Concentration risk | Too much collateral in single issuer | Concentration limits in CSA |
| Liquidity risk | Cannot liquidate collateral quickly | Restrict to liquid instruments |
| FX risk | Collateral currency differs from exposure | Currency haircuts or restrictions |
Operational Risks
| Risk | Description | Mitigation |
|---|---|---|
| Failed delivery | Collateral not received on time | Monitoring and escalation procedures |
| Reconciliation breaks | Parties disagree on holdings | Daily reconciliation |
| System failures | Margin systems unavailable | Business continuity planning |
| Custodian issues | Third-party fails to transfer | Dual custody arrangements |
Threshold and MTA Tradeoffs
| Factor | High Threshold | Low Threshold |
|---|---|---|
| Credit exposure | Higher | Lower |
| Operational burden | Lower | Higher |
| Collateral efficiency | Better | Worse |
| Regulatory compliance | May not meet | Compliant |
Post-crisis regulations largely eliminate thresholds for covered entities.
Common Pitfalls
| Pitfall | Description | Prevention |
|---|---|---|
| Timing mismatch | Different notification times across CSAs | Standardize operational procedures |
| Haircut disputes | Disagreement on applicable haircut | Reference specific securities in schedule |
| Interest rate differences | Dispute over collateral interest rate | Specify rate source (e.g., Fed Funds) |
| Substitution delays | Slow collateral substitution process | Agree on substitution procedures |
Initial Margin Requirements
Post-2016 regulations require covered entities to exchange Initial Margin (IM):
IM calculation approaches:
| Method | Description |
|---|---|
| Standard Schedule | Regulatory grid based on notional |
| ISDA SIMM | Risk-based model using sensitivities |
SIMM calculation: IM = f(Delta, Vega, Curvature) with correlation adjustments
Standard Schedule example:
| Asset Class | IM Rate |
|---|---|
| Interest rate | 1-4% of notional |
| Credit (IG) | 2% |
| Credit (HY) | 5% |
| Equity | 15% |
| Commodity | 15% |
| FX | 6% |
Checklist and Next Steps
CSA negotiation checklist:
- Confirm threshold amounts for each party
- Set appropriate Minimum Transfer Amount
- Define eligible collateral with haircuts
- Specify valuation timing and agent
- Establish notification deadlines
- Include dispute resolution procedures
- Address interest on cash collateral
- Consider rehypothecation rights
- Review Initial Margin requirements
Operational checklist:
- Establish daily margin calculation process
- Set up collateral custody arrangements
- Implement reconciliation procedures
- Define escalation for disputes
- Create margin call templates
- Test operational readiness
Related articles:
- For ISDA fundamentals, see ISDA Master Agreement Overview
- For margin types, see Initial Margin vs. Variation Margin in OTC Trades