Exposure - NY VM CSA Provision

2016 ISDA Credit Support Annex (VM) (New York law) A Jolly Contrarian owner’s manual™ Go premium Overview — Summary — Premium — See also — Wikitext Crosscheck: →NY OG →Eng OG →NY VM →Eng VM →Eng IM Exposure in a Nutshell™ The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack. You can even ask questions! Ask about it here. Original text “Exposure” means, unless otherwise specified in Paragraph 13, for any Valuation Date or other date for which Exposure is calculated and subject to Paragraph 5 in the case of a dispute: (i) if this Agreement is a 1992 ISDA, the amount, if any, that would be payable to a party that is the Secured Party by the other party (expressed as a positive number) or by a party that is the Secured Party to the other party (expressed as a negative number) pursuant to Section 6(e)(ii)(2)(A) of this Agreement as if all Covered Transactions were being terminated as of the relevant Valuation Time on the basis that the Base Currency is the Termination Currency; provided that Market Quotation will be determined by the Valuation Agent on behalf of that party using its estimates at mid-market of the amounts that would be paid for Replacement Transactions (as that term is defined in the definition of “Market Quotation”); and (ii) if this Agreement is an 2002 ISDA or a 1992 ISDA in which the definition of Loss and/or Market Quotation has been amended (including where such amendment has occurred pursuant to the terms of a separate agreement or protocol) to reflect the definition of Close-out Amount from the pre-printed form of the 2002 ISDA as published by ISDA, the amount, if any, that would be payable to a party that is the Secured Party by the other party (expressed as a positive number) or by a party that is the Secured Party to the other party (expressed as a negative number) pursuant to Section 6(e)(ii)(1) (but without reference to clause (3) of Section 6(e)(ii) of this Agreement as if all Covered Transactions were being terminated as of the relevant Valuation Time on the basis that the Base Currency is the Termination Currency; provided that the Close-out Amount will be determined by the Valuation Agent on behalf of that party using its estimates at mid-market of the amounts that would be paid for Transactions providing the economic equivalent of (X) the material terms of the Covered Transactions, including the payments and deliveries by the parties under Section 2(a)(i) in respect of the Covered Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date (assuming satisfaction of the conditions precedent in Section 2(a)(iii)), and (Y) the option rights of the parties in respect of the Covered Transactions. The varieties of ISDA CSA Subject 1994 NY 1995 Eng 2016 VM NY 2016 VM Eng 2018 IM Eng Preamble Pre Pre Pre Pre Pre Interpretation 1 1 1 1 1 Security Interest 2 - 2 - 2 Credit Support Obligations 3 2 3 2 3 Transfers, Calculations and Exchanges - 3 - 3 - Conditions Precedent, Transfer Timing, Calculations and Substitutions 4 - 4 - 4 Dispute Resolution 5 4 5 4 5 Holding and Using Posted Collateral 6 - 6 - 6 Transfer of Title, No Security Interest - 5 - 5 - Events of Default 7 6 7 6 7 Rights and Remedies 8 - 8 - 8 Representations 9 7 9 7 9 Expenses 10 8 10 8 10 Miscellaneous 11 9 11 9 11 Definitions 12 10 12 10 12 Elections and Variables 13 11 13 11 13 Resources and Navigation Index: Click ᐅ to expand: CSA

Comparisons

Redlines

• 1994 ⇒ 1995: Redline of the ’94 NY vs. the ’95 English: comparison (and in reverse)
• 1995 ⇒ 2016: Redline of the ’95 English vs. the ’16 VM English: comparison (and in reverse)

I will try to get round to the others later.

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Discussion

Ancient v Modern

The difference between the Ancient and Modern versions of the CSA is that the OG CSAs assume you are trading under a 1992 ISDA, therefore using the Market Quotation valuation technique — which figures, since the 2002 ISDA with its Close-out Amount methodology hadn’t then been invented — whereas the Modern CSAs contemplate you having a either a 1992 ISDA or a 2002 ISDA and provides for them in the alternative.

Here is a comparison between the 1995 CSA and the 2016 VM CSA

NY v English law

The 2016 NY Law VM CSA tracks the 2016 VM CSA closely with two curious exceptions: Firstly, when imagining its hypothetical termination of all Transactions it doesn’t explicitly carve out the Transaction constituted by the 2016 NY Law VM CSA itself — which is odd, because if you were treating it as a Transaction to be hypothetically included, you necessarily get a value of zero, since its value should be the exact negative of whatever the net mark-to-market value of all the other Transactions are — and secondly it does not hypothetically suppose that the Secured Party is the Unaffected Party, thereby getting to be in the driver’s seat when constructing the necessary valuations.

The reason you don’t have to except a 2016 NY Law VM CSA from hypothetical termination is buried deep in its earthen ontological root system. It is not a Transaction.

Basics

Deep differences between NY and English law CSAs

Unlike a title transfer English law CSA which is expressed to be a Transaction under the ISDA Master Agreement, the 2016 NY Law VM CSA is not: it is instead a “Credit Support Document”: a standalone collateral arrangement that stands aloof and apart from the ISDA Master Agreement and all its little diabolical Transactions.

The reason for this is intensely philosophical: because a English law CSA is a title transfer collateral arrangement, it reverses the indebtedness between the parties outright. An 2016 NY Law VM CSA (and, for that matter, an English law English law CSD) does not: it only provides a security interest for the indebtedness: the in-the-money counterparty is still in-the-money. It is just secured for that exposure. The outright exposure between the parties does not change.

This is the magical, bamboozling stuff of deep ISDA lore. At least where “rehypothecation” is permitted under a 2016 NY Law VM CSA — it pretty much always is — the practical distinction makes no real difference, because even though you say you are only pledging the collateral, in the greasy light of commercial reality, from the moment the Secured Party rehypothecates your pledged assets away into the market, dear Pledgor, you have transferred your title to your collateral outright.

“Exposure” in summary

The total mark-to-market exposure under your ISDA Master Agreement on a given day, not counting anything posted by way of credit support.

That is, Exposure omits the mark-to-market exposure of the Transaction comprising the CSA itself — if it is a Transaction; if it isn’t, it wouldn’t be an in scope Exposure in the first place — because that would entirely bugger things up: the mark-to-market value of of an ISDA including its credit support annex is, of course, more or less zero.

Section 6 of the ISDA and the peacetime operation of the Credit Support Annex

The calculation of Exposure under the CSA is modelled on the Section 6(e)(ii) termination methodology, subjunctively following a hypothetical Termination Event where there is one Affected Party, which in turn tracks the Section 6(e)(i) methodology following an Event of Default, only taking mid-market valuations and not those on the Non-Defaulting Party’s side.

This means you calculate the Exposure as:

1. The Close-out Amounts for each Terminated Transaction plus
2. Unpaid Amounts due to the Non-defaulting Party; minus
3. Unpaid Amounts due to the Defaulting Party.

There aren’t really likely, in peacetime, to be Unpaid Amounts loafing about — an amount that you are due to pay today or tomorrow wouldn’t, yet, qualify as “unpaid”, but would be factored into the Close-out Amount calculation. But there might be: see the premium content section of Transaction terminations and VM for a hypothetical case where it might happen, and why you needn’t worry too much about it. The point to take away is that the Exposure calculation is a subjunctive termination calculation: it is the calculation you would make if there had been an Event of Default and you were to have designated an Early Termination Date; the natural expectation is that you will not have.

Sorry for all that tense-contortion, folks.

“Exposure” is a snapshot calculation that treats all future cashflows the same way, whether due in a day, a month or a year: it discounts them back to today, adds them up and sets them off. Your Delivery Amount or Return Amount, as the case may be, is just the difference between that Exposure and the prevailing Credit Support Balance. The future is the future: unknowable, unpredictable, but discountable, whether it happens in a day or a thousand years.

“Mid-market”?

Why the adjustment from your “side of the market”, which is where you would calculate a real 6(e)(ii) amount, to be determined at the mid-market price?

Well, since no-one has defaulted, this is fair enough, and if each party used its own side of the market, the Credit Support Balance could never find stability or happiness, even fleetingly, and the credit support world would be in some kind of infinite payment loop.

Premium content

Here the free bit runs out. Subscribers click 👉 here. New readers sign up 👉 here and, for ½ a weekly 🍺 go full ninja about all these juicy topics👇 JC’s “nutshell” summary of the clause Background reading and long-form essays The curious timing mismatch “Market Quotation” where you have a 2002 Master Calculating your Credit Support Amount OG CSAs Modern CSAs with no IA amendment Modern CSAs with a customised IA amendment Transaction and collateral flows

See also

• Transaction terminations and VM