Credit Support Annex

Credit Support Annex is a document published by the International Swaps and Derivatives Association (ISDA). It provides guidelines to conduct bilateral margin collateral arrangements that are entered between counterparties into single or several over-the-counter (OTC) derivatives. It forms part of ISDA's master agreement.

The primary reason for its establishment is to deal with the use of available market securities or cash to secure exposure or risks to either or both parties. This annex provides flexibility for involved parties in credit support arrangement structuring in accordance with the ISDA.

The credit support annex (CSA) is a document that governs the conduct of bilateral credit support and security arrangements under the ISDA master agreement. The agreement allows the mitigation of counterparty credit risks through the posting of collateral. Counterparty credit risk is the risk associated with the non-fulfillment of obligations as per the agreement (may be due to insolvency or lack of liquidity). The agreement is often used by parties using OTC trading. The CSA can be customized between counterparties based on the types of collateral, minimum transferable amounts, thresholds, and margins.  

A credit support annex agreement includes:

• Eligible credit support.
• An independent amount.
• Margin calls.
• Margin call frequency.
• A threshold amount.
• A minimum transfer amount.

Eligible credit support talks about collaterals that could be posted, such as cash or cash equivalents, government securities, etc. The Independent amount is the initial amount that is required by the parties to transfer to mark the beginning of the deals. It can also be the sum that is agreed to be transferred while the agreement is carried out in case the risk exposure requires it. Credit support annex independent amount is executed when there are changes in counterparties' risk profile, such as a credit rating downgrade.

Margin calls are demands made between parties to deposit additional collateral to avoid potential loss arising out of over-exposure. Margin call frequency deals with the timescale of calling the collateral. The credit support annex threshold amount is the amount of unsecured exposure allowed by parties before margin calls are made. Lastly, the minimum amount transfer deals with the least amount that is transferable in a marginal call. The amount will be mentioned in the agreement.

Let us look into some examples to understand the concept better.

Example #1

Imagine that party A is transacting business with party B. They are both large financial institutions that plan to engage in over-the-counter transactions. They opt to enter into the deal by signing up through the CSA. The agreement specifies a credit support annex threshold, minimum transfer amounts, and the CSA independent amount, among other things. This clearly drafted agreement helps both parties to reduce risks associated with the transaction. They opted for the arrangement as it not only reduces the risks but also allows customization as per each party's requirement.

Example #2

A master agreement was agreed in 2006 (September 26) between Barclays Bank and Omni Auto Receivables Trust. The document contains detailed information on the conditions agreed between the two parties. Apart from the usual components, it also mentions the delivery amount for additional collateral and mentions the timing and calculations to determine the collateral and the transfer thereof. It also outlines the responsibilities regarding the custody of collateral posted.

Given below are some of the benefits that corporations would experience after entering into a CSA. They are:

• Mutual Risk Reduction: It helps corporations obtain better pricing on their hedging transactions. This is due to a reduction in funding and credit charges.
• Flexibility In Trade Relationships: The CSA facilitates easy trade between big banks and provides the best service quality and pricing along with the elimination of concentration risk. It provides better access to products such as bilateral loans, credit extension, etc.
• Liquidity Management: It enables the optimization of counterparties' liquidity positions. This is facilitated through the use of collaterals. Parties could use securities such as bonds as collateral instead of cash reserves to maintain margin requirements and liquidity.
• Transparency: Agreements to CSA can help parties be transparent in their deals. This helps them identify practices that may lead to credit risks and take preventive measures against them.

Some differences between the concepts are given below.