On 14 April 2016 ISDA published the New York law “2016 Credit Support Annex for Variation Margin (VM)” (the “NY-law VM CSA”). Subsequently, on 29 April 2016 it published the English law “2016 VM Credit Support Annex for Variation Margin (VM)” (the “English-law VM CSA” and together with the NY-law VM CSA, the “VM CSAs”).
The VM CSAs are designed to facilitate compliance with the requirement to post variation margin pursuant to the BCBS/IOSCO “Working Group on Margin Requirements” (WGMR) non-cleared margin rules, which will take effect – for the largest market participants – on 1 September 2016 (“Phase 1”).
A Job Well Done?
The VM CSAs are as clear and concise as can be expected in the circumstances and one has to applaud the effort that has gone into their drafting. Only those amendments that are necessary in order to implement the WGMR VM rules have been incorporated, although some changes have been made to account for the possibility of negative interest rates. Nonetheless, viewed objectively, they are still complicated documents with many elections. As such, and given that the VM CSAs are destined to become the industry standard template, users of the document will have to spend some time familiarising themselves with the new drafts. In order to assist with this process, a summary of the main changes between (a) the traditional New York law CSA and English law CSA, and (b) the VM CSAs is provided in the Schedule to this note.
Will There be a Protocol Solution?
An ISDA protocol, designed to facilitate WGMR compliance, is anticipated. However, it is believed that its main focus will be on ‘Phase 2’ of VM CSA repapering which will commence in March 2017. Current estimates suggest that the protocol is unlikely to be published before August/September 2016, rendering it of little practical assistance in relation to ‘Phase 1’ repapering efforts in any event. Given the complexity of the underlying subject matter, it is difficult to imagine a protocol being any less complicated than the VM CSAs it is designed to mirror. Furthermore, as an essentially public exercise, one wonders about the extent to which firms will be happy to, in effect, broadcast the contents of their CSAs to the world – even in circumstances where the contents of those CSAs are largely dictated by law. This may adversely impact accession rates, bringing into question the usefulness of a protocol solution in relation to ‘Phase 2’ amendments.
Planning a way forward
Current schools of thought suggest that there may ultimately be as many as 4 CSAs for each ISDA Master Agreement currently in existence (one for legacy VM transactions, one for ‘WGMR regulated’ VM transactions, one for legacy initial margin (IM) transactions, and one for ‘WGMR regulated’ IM transactions). The convoluted nature of the document structure combined with the likely complexity of any ISDA protocol solution – which will inevitably lead to a high degree of client education in any event – has resulted in a number of firms making plans to pursue bilateral renegotiation of their CSA portfolios rather than wait for the implementation of an industry solution. In these circumstances, the publication by ISDA of a high-quality template document which facilitates bilateral amendments is even more welcome and timely.
Coming hot on the heels of regulation requiring the inclusion of contractual stays and early termination rights in financial contracts for the purposes of RRP, CSA repapering for the purposes of WGMR compliance promises to keep documentation teams extremely busy over the next 12-24 months. Balancing the WGMR requirements against BAU needs will present resourcing challenges for many firms. Resource available both internally and externally is likely to become a constraining factor as deadlines loom. As such, firms which are subject to the WGMR rules – even those which are only subject to ‘Phase 2’ requirements – should already have begun their project planning.
It is wise to proceed on the assumption that the process of amending a CSA portfolio of any size will take 6-9 months. In advance of dispatching documentation, it is advisable to triage clients, for instance, by revenue, risk or jurisdiction. An approach to CSA repapering for each group should then be defined. For example, will limited (or full) negotiation be entertained or will new documentation be presented on largely a ‘take it or leave it’ basis, reflecting the mandatory nature of many of the WGMR CSA changes and the looming deadlines in which compliance must be achieved? Once this question has been answered, and now that template documentation has been produced which puts meat on the bones of the WGMR rules, firms will be better placed to commence negotiations – again by priority.
How we can Help
DRS specialises in helping clients which have documentation that needs to be managed – negotiated, analysed and amended. We provide a flexible and scalable end-to-end solution which enables clients to rapidly and efficiently negotiate and remediate document portfolios and to gain insight into contractual obligations. Our services directly impact the bottom line by facilitating smarter business decisions – mitigating risk, strengthening compliance, unlocking commercial opportunity and improving operational efficiency by up to 46%. They are the perfect solution for those firms without the permanent headcount to resource projects of this type or the appetite to recruit, train and manage significant numbers of temporary staff.
The VM CSAs only apply to “Covered Transactions”, a concept which allows parties to restrict the scope of a VM CSA by reference to the:
- Transaction date – with only transactions executed after a specific date being covered; and
- Transaction type – with the parties being able to include or exclude specific transaction types, including:
- Swaps (uncleared only);
- Security-Based Swaps (uncleared only);
- OTC Derivatives (as defined under EMIR);
- Physically Settled FX Forwards; and
- Physically Settled FX Swaps.
Credit Support Obligations
As their name suggests, the VM CSAs only deal with the transfer of VM. As such, the concept of an “Independent Amount” – a concept synonymous with initial margin – is no longer relevant and has been deleted from both templates.
Credit Support Amount
The concept of the “Credit Support Amount”, previously found in both the traditional New York law CSA and the traditional English law CSA has been removed from the new VM CSAs, on account of its redundancy. The “Credit Support Amount” was made up of (a) the Secured Party’s/Transferee’s Exposure, plus (b) Independent Amounts of the Pledgor/Transferor, less (c) Independent Amounts of the Secured Party/Transferee, less (d) the Threshold of the Pledgor/Transferor.
As mentioned above, “Independent Amounts” are irrelevant in the context of a VM-only CSA. In addition, the concept of a “Threshold” is also superfluous due to the WGMR requirement to implement zero-thresholds for VM transfers. As such, the only factor that remains from the original definition of “Credit Support Amount” is the concept of “Exposure” of the Secured Party/Transferee – which has accordingly replaced the “Credit Support Amount” as the basis of the “Delivery Amount” calculation.
The “Delivery Amount” (now called “Delivery Amount (VM)”) operates in the same way as under the traditional New York law CSA and the traditional English law CSA (i.e. Eligible Credit Support must be transferred if the Delivery Amount (VM) exceeds the Pledgor’s/Transferor’s Minimum Transfer Amount). However, the actual calculation of the “Delivery Amount (VM)” differs from the calculation of “Delivery Amount” under a traditional CSA due to the removal of the concept of the “Credit Support Amount” (see “Credit Support Amount” above for more detail).
The “Return Amount” (now called “Return Amount (VM)”) also operates in the same way as under a traditional CSA (i.e. Eligible Credit Support must be transferred if the Return Amount (VM) exceeds the Secured Party’s/Transferee’s Minimum Transfer Amount). Again, however, the actual calculation of the “Return Amount (VM)” differs from the calculation of the “Return Amount” under a traditional CSA due to the removal of the concept of the “Credit Support Amount”. As such, the “Return Amount (VM)” is equal to ‘Posted Credit Support/Credit Support Balance minus the Secured Party’s/Transferee’s Exposure’, rather than ‘Posted Credit Support/Credit Support Balance minus Credit Support Amount’ (as is the case under a traditional CSA).
The concept of the “Threshold” has been removed. As mentioned above, the WGMR rules demand that zero thresholds apply in relation to VM, making the concept redundant.
Minimum Transfer Amount (MTA)
The concept of the MTA operates in exactly the same way as under a traditional CSA. The parties are free to specify the MTA, although WGMR rules (as implemented locally) require that this is a maximum of USD/EUR 500,000 per counterparty, allocated across both VM and IM.
Concepts of “Base Currency” and “Eligible Currency” (essentially identical to that under an English law CSA) have been introduced into the New York law VM CSA so as to facilitate the posting of non-USD denominated cash and securities.
The concept of a “Valuation Percentage” (i.e. a haircut) is introduced to cash valuations as well as securities valuations in relation to the New York law VM CSA. The parties also have the option in both VM CSAs to include additional language which, irrespective of what that CSA may state, caps the Valuation Percentage at the maximum allowed by applicable regulation. Finally, an “FX Haircut Percentage” has also been introduced in order to comply with the WGMR rules requiring an 8% FX haircut if there is a difference between the currency of the collateral asset and the currency of settlement.
Whereas previously the “Valuation Date” could be specified by the parties, now it is hardwired into the agreement as being daily (unless otherwise specified).
Eligible Credit Support
The concept of Eligible Credit Support operates in broadly the same way as under a traditional CSA. However, two new points are worthy of note:
- The parties can specify conditions (“Credit Support Eligibility Conditions”) which must be satisfied before an item can qualify as “Eligible Collateral (VM)”/”Eligible Credit Support (VM)”; and
- The Secured Party/Transferee is given the ability to notify the Pledgor/Transferor (via a “Legal Ineligibility Notice”) that items of Eligible Credit Support no longer comply with legal requirements applicable to the Secured Party/Transferee and so can no longer be accepted. Note further that the parties can effectively agree to ‘turn off’ the ability of a party to serve a “Legal Ineligibility Notice”.
As mentioned above, the concepts of a “Base Currency” and “Eligible Currency” have been introduced to the New York law VM CSA so as to facilitate the posting of non-USD denominated cash and securities.
A new concept of a “Regular Settlement Day” has been introduced into the collateral transfer timing. This has the effect of reducing the time given to effect a transfer of collateral from the Local Business Day after a demand was made (as was previously the case) to the same Local Business Day on which a demand is made.
The default “Notification Time” (used for the purposes of making collateral demands and notifying parties of collateral calculations) has been brought forward from 1:00 pm New York time to 10:00 am New York time (in the case of the New York law VM CSA) and from 1:00 pm London time to 12:00 noon London time (in the case of the English law VM CSA).
The obligations of a party to transfer collateral under the New York law VM CSA are subject to fulfilment of the conditions precedent by the other party (being, broadly, that no Event of Default, Potential Event of Default, Specified Condition, or Early Termination Date has arisen). The New York law VM CSA has extended the scope of the conditions precedent to include the transfer obligations which arise under:
- Paragraph 5 (“Dispute Resolution”) – so that a party will not have to transfer undisputed amounts (pending a recalculation) or additional Eligible Credit Support (following a recalculation) if a Condition Precedent is not met; and
- Paragraph 6(d) (“Interest Amount (VM) and Interest Payment (VM)”) – so that payments of interest do not have to be made if a Condition Precedent is not met.
There are some relatively minor amendments to the mechanics of the dispute resolution process and the valuation of “Exposure”.
Changes have been made to the payment of interest to:
- Account for the possibility of negative interest rates;
- Allow the “Interest Payer (VM)” to net payments of interest owed by it against Delivery Amounts (VM) or Return Amounts (VM) that may be due to it from the other party; or
- Allow amounts of posted collateral to be adjusted by the Secured Party/Transferee so as to (a) give the Pledgor/Transferor credit for any positive Interest Amount (VM) owed to it by the Secured Party/Transferee by automatically adding an amount equal to that Interest Amount (VM) to the balance of posted collateral, and (b) by reducing the balance of any cash forming part of the posted collateral by an amount equal to any negative Interest Amount (VM) (i.e. monies owed by the Pledgor/Transferor to the Secured Party/Transferee due to the operation of negative interest rates) – this may in turn trigger a call for an additional collateral from the Pledgor/Transferee.
The Default Interest provisions are expanded to specifically include reference to the payment of “Interest Payment (VM)”.
Rights Following Default
Secured Party’s rights following a Pledgor Default
The rights of the Secured Party under a traditional New York law CSA to set-off or apply proceeds following a liquidation of collateral have been expanded slightly under the New York law VM CSA to include amounts which the Secured Party may owe a defaulting Pledgor under “Other CSAs” (for example the separate CSA that will document the transfer of IM).
Pledgor’s rights following a Secured Party Default
The Pledgor under a New York law VM CSA also has a right to set-off amounts received under “Other CSAs” against amounts of Posted Collateral which a defaulting Secured Party is obliged to return to the Pledgor.
Return of Posted Credit Support (VM)/Equivalent Credit Support (VM)
A new clause has been inserted which states that, provided that all conditions precedent have been satisfied and the Pledgor/Transferor has satisfied all of its obligations to transfer collateral, the Secured Party/Transferee is required to transfer all Posted Collateral/Equivalent Credit Suport which has a value of zero back to the Pledgor/Transferor following receipt of a demand for the same.
Reinstatement of Credit Support Eligibility
A new clause has been inserted which allows the Pledgor/Transferor to request the Secured Party/Transferee to revisit previous decisions as to whether an item of collateral (or an amount of that item) satisfies collateral eligibility requirements under applicable law.
Credit Support Offsets
A new clause has been inserted which allows the parties to specify whether the concept of “Credit Support Offsets” is applicable to their relationship. The effect of this is to allow the parties to effectively ‘payment net’ transfers of collateral between CSAs, provided that the collateral in question is fungible and is not required to be segregated.
 Which are not subject to the WGMR requirements
 Paragraph 13(b)(i) of the NY-law VM CSA and paragraph 11(b)(i) of the English-law VM CSA
 See paragraph 13(c)(v) of the NY-law VM CSA and paragraph 11 (c)(v) of the English-law VM CSA
 The vast majority of WGMR rules (as implemented locally) do not require an FX haircut on collateral in the form of cash, a notable exception, in part, being the rules of the CFTC and Prudential Regulators in the US under which no FX haircut is required on cash collateral provided that it is denominated in a Major Currency: (1) US Dollars, (2) Canadian Dollars, (3) Euro; (4) UK Pounds, (5) Japanese Yen, (6) Swiss Franc, (7) New Zealand Dollar, (8) Australian Dollar, (9) Swedish Kronor, (10) Danish Kroner, (11) Norwegian Krone, (12) Any other designated currency.
 See definition of “Valuation Date”
 See paragraph 13(c)(iv) of the NY-law VM CSA and paragraph 11(c)(iv) of the English-law VM CSA
 See paragraph 11(g) of the NY-law CSA and paragraph 9(e) of the English-law VM CSA
 See paragraph 13(c)(iii) of the NY-law VM CSA and paragraph 11(c)(iii) of the English-law VM CSA
 See paragraph 6(d)(A) of the NY-law VM CSA and paragraph 5(c)(ii)(A) of the English-law VM CSA
 See paragraph 6(d)(B) of the NY-law VM CSA and paragraph 5(c)(ii)(B)
 See paragraph 8(a)
 See paragraph 8(b)
 See paragraph 8(b)(iv)
 See paragraph 8(b)(iii)
 See paragraph 11(h) of the NY-law VM CSA and paragraph 9(f) of the English-law VM CSA
 Relevant to the NY-law VM CSA only
 See paragraph 11(i) of the NY-law VM CSA and paragraph 9(g) of the English-law VM CSA
 Presumably, this is to facilitate compliance with concentration limits and restrictions on ‘wrong-way risk’ collateral
 See the definition of “Other CSA Excluded Credit Support”Contact Us