Netting and Collateral

Abstract

As already explained in Section 5.5, many of the features of a CSA cannot be priced by adjusting the discount curve but have to be included in a simulation which is capable of computing path-wise future exposures. We saw in Chapter 5 and Section 12.4 that one exception is the option to switch the currency of the posted collateral.¹ When estimating counterparty exposure, the following use-cases can be distinguished:

• A counterparty portfolio which is not covered by any ISDA or similar² netting agreement; i.e. no netting of trade exposures is possible.

• A counterparty portfolio which is fully covered by an ISDA or similar netting agreement; i.e. netting of trade-level exposures is valid.

• A counterparty portfolio covered by an ISDA agreement containing a Credit Support Annex (CSA); in this instance the aggregate portfolio exposure may be mitigated via the exchange of collateral. A CSA always comes together with a netting agreement.

• A counterparty portfolio which is only partially covered by an ISDA agreement; in such a case only a subset of the portfolio is eligible for netting and collateralization.

All these cases are covered by the methodology described below. The definition of ISDA master agreement and CSA was given in Chapter 5.