ISDA Publishes the 2016 Credit Support Annexes for Variation Margin: What does it provide for?
On 13th April 2016, ISDA published the 2016 Credit Support Annex for Variation Margin, governed by New York law (“NY VM CSA”). This was followed on 29th April 2016 by the publication of the 2016 Credit Support Annex for Variation Margin, governed by English law (“Eng VM CSA”). More recently the Japanese law version of the VM CSA was also published.
These new documents will enable participants in the un-cleared derivatives market to comply with new variation margining requirements as laid out by the Basle Committee on Banking Supervision and the International Organization of Securities Commissions (and which have been largely adopted into the EMIR and Dodd Frank regulations). These rules will take effect for the largest market participants on 1st September 2016, with other entities following suit in March 2017. Initial margin requirements will be phased in over the next 4 years, and ISDA will publish initial margin documentation in due course.
US regulators published their final rules pertaining to margining of un-cleared derivatives at the end of 2015, Europe and Japan followed suit in March 2016. The margin requirements for un-cleared derivatives have yet to be published by National Treasury in South Africa, but are expected imminently.
These new CSAs will enable parties to negotiate the collateral terms pertaining to variation margin, within scope of the regulations. The new CSAs have many elective provisions and give users the choice between amending legacy CSAs or entering into new CSA documentation.
Whilst ISDA have suggested that a protocol may be published to aid the transition to these new documents; given the elective nature of the CSA, and the fact that participants may wish to retain the confidentiality of their collateral terms, signing the protocol may not be the answer for all firms.
Key differences between the 1994/1995 NY law and English law CSAs (“Existing CSAs”) and the new NY VM CSA and Eng VM CSA
Like under the Existing CSAs, the VM CSAs provide for the transfer of variation margin collateral on a net basis to cover exposure.
The Existing CSAs provided for both VM and IM. However, the VM CSAs only deal with the posting of variation margin. The initial margin requirements, which will be published in due course, will require separate CSAs to document the IM portion of collateral that is required. Parties will have to post initial margin on a gross basis, and will require this initial margin to be segregated from the proprietary assets of the counterparty.
Under the VM CSAs parties have the option to only document new trades entered into after the relevant implementation date using the VM CSAs, or to also include legacy transactions that are amended after implementation date. As a result, the definition of Covered Transactions becomes important. The new definition of Covered Transactions becomes important as it enables parties to limit the scope of a VM CSA to reference:
only those transactions entered into after a certain date, and
only certain types of transactions, depending on what the regulations require.
Some parties may even decide not to have two CSAs in place covering different portfolios of transactions, but rather to sign new CSAs for all their transactions.
The interest provisions of the VM CSAs have been amended to deal with a negative interest rate environment.
Other new provisions in the VM CSAs include valuation haircuts, shorter collateral transfer times, and provisions that relate to when collateral becomes ineligible.
Since the VM CSAs only cover variation margin, the definition and concept of Independent Amount (which relates to an initial margin requirement) does not feature in the VM CSAs.
The Existing CSAs provide for thresholds, such that a party has to post collateral only once the exposure has exceeded the stipulated threshold, and only post enough to reduce exposure down to threshold amount. However under the new margin regulations, only zero thresholds are tolerated, and as such a requirement to define a threshold amount is redundant in the VM CSAs.
Accordingly, the definition and concept of Credit Support Amount (which is defined in the Existing CSAs as the exposure and independent amounts less the threshold amounts) has been deleted from the VM CSAs, and reference is just made to the exposure amount. As a result, in the VM CSAs, the definitions of Return Amount and Delivery Amount (which in the Existing CSAs refer to the definition of Credit Support Amount) simply reference the collateral amount as compared to the exposure – although conceptually they operate in the same way.
The concept of a Minimum Transfer Amount remains in the VM CSAs, although there is now a maximum MTA of USD/EUR 500 000 per counterparty required under the new regulations.
The concept of providing for a haircut on cash margin (as well as securities margin) has been implemented under the VM CSAs. Valuation Percentage caps can also be provided for as well as an FX Haircut Percentage which enables parties to comply with the rules requiring an 8% FX Haircut if there is a difference between the collateral asset currency and the settlement currency.
Under the Existing CSAs, parties can agree to various different Valuation Dates, which determine when collateral is called for. Under the new regulations, daily margining is required, and this has therefore been included as standard in the VM CSAs.
In terms of eligibility of collateral: under the VM CSAs, parties can agree to certain conditions, which determine the eligibility of collateral types, and the party holding the collateral also has the option to notify the posting party that eligible collateral is no longer compliant with regulatory requirements and can therefore no longer be accepted.
Collateral transfer times have been reduced in the VM CSAs. Collateral must transfer on the same day if a call is made before Notification Time, or the next day if a call is made after Notification Times. Likewise the Notification Time making a collateral call has been brought forward to 10am New York time in the NY VM CSA, and 12 noon London time in the Eng VM CSA.
Under the Existing NY CSA the obligation to transfer collateral does not have to be made until the conditions precedents are met (no event of default, potential event of default, early termination date or special condition has arisen and is continuing). Under the NY VM CSA the conditions precedent also applies to payments of undisputed amounts if there is a dispute, and payments of interest.
Set off rights after an event of default have been hard wired into the VM CSAs such that amounts due under separate CSAs can be off set against each other. This means that if parties have multiple CSAs with a party, amounts owing under these can be set off against each other post default.
A clause providing for parties to elect to apply Credit Support Offsets to their relationship has been included. If elected to apply, this will allow parties to transfer net amounts of collateral between different CSAs as long as the collateral does not require segregation, and as long as it is fungible.
For more information on collateral arrangements, register now for the DeriviDoc course:
Collateral and the CSA Master Agreements
This course has recently been improved and updated to include coverage of the following topics:
collateral management in the new regulatory environment focusing on collateral requirements under EMIR, Dodd Frank and the Financial Markets Act
collateral requirements in the cleared and un-cleared space
variation margin and initial margin
main elements of the 2016 VM CSAs.
DeriviDoc can also assist with any necessary re-papering work to help clients get new CSAs in place and in-line with regulatory requirements.
Melissa van der Merwe (DeriviDoc Director)
12 July 2016