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Cross-currency collateral ousted from SCSA 2

On 6 November 2014, ISDA released the 2014 “Standard” Credit Support Annex, available as always under English law or New York law.

This new CSA is meant to coexist with the legacy 1994 CSA and the already out-of-fashion 2013 CSA published only a year ago. What was presented as a tour de force in the 2013 version – eliminating the 17-dimensional Herstatt risk to the swap market via a single Transport Currency – now represents its greatest weakness in the light of adverse regulatory developments. An arbitrary 8% haircut is envisioned for cross-currency collateral in the EU and in the US, certainly prohibitive enough for market participants to stay away from the Transport Currency.

Yet at the time the 2013 version was released, it was hoped that market participants would gradually adopt it for the benefits it offered. In particular, the CSA eliminated embedded optionality in the delivery of variation margin by restricting it to hard currency. Indeed, the right to deliver or substitute collateral in the form of various assets proved a real challenge in valuing collateralised transactions.

The CSA 2014 aims to preserve the benefits introduced in the latest version, while addressing the costly regulatory issues arising from the mismatch between the currency of the exposure and the collateral. The currency-silos will be managed as silos. Accordingly, the exposure in a currency would trigger a variation margin delivery in the exact same currency.

Industry initiatives are ongoing in order to address the Herstatt risk unleashed in the CSA 2014, most probably via a payment versus payment (PvP) framework. Both the CSA 2014 and the industry solutions will be of particular interest to market participants with multiple currency exposures.

For the sake of standardisation, amendments to the CSA are likely to be strongly discouraged. Nonetheless, the CSA provides for default provisions on IM, VM, minimum transfer amount and right to reuse the collateral which may not be desirable for the parties and perhaps not exactly in tune with the upcoming regulations on margin of non-cleared derivatives due to apply from December 2015.

In this context, the standard CSA 2014 may not be a standard, but rather a starting point for negotiation.

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