CSA Discounting

Abstract

The International Swaps and Derivatives Association (ISDA) presented the so-called master agreement in 1987 (USD only), an updated version in 1992, and a further update in 2002. All of these master agreement types are still in use because many have not yet been updated. The master agreement allocates the financial risks in transactions between two counterparties without containing specific commercial information for individual trades, it just gives a framework for the portfolio of trades between the two signing parties. For instance, Section 5 of the master agreement defines “Events of Default” and “Termination Events”, and Section 6 clarifies the conditions under which early termination of transactions is possible for one party if such events occur, including close-out and netting. Nowadays, the MA usually has a Credit Support Annex (CSA) which details the collateralization provisions:

• Which side has to post collateral (this can be restricted to either side, or both have to post collateral). Obviously, it makes a big difference if one party is exempt from posting collateral: It will have reduced counterparty credit risk itself, but its counterparty faces the full credit exposure. The collateral is intended to mitigate net or “netting set” exposures; i.e. it is held against the entire portfolio of OTC contracts covered by the ISDA agreement.

• Thresholds, (MTA) and collateral call frequency. The threshold gives a minimum level of net exposure that has to be reached so that collateral has to be posted. It can be different for the two parties involved, or be variable depending on each party’s rating. In some cases, the threshold can also change deterministically over time. Evidently, the case where only one side has to post collateral can be represented by a threshold of infinite size.