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Set out the terms found in a collateral agreement and the main features of a credit support annex (CSA) in an ISDA Master Agreement: credit support amount, credit quality, haircuts, rounding, minimum transfer amount, initial margin and threshold.

FRM® Part II · Credit Risk Measurement and Management · Margin (Collateral) and Settlement · FRM2.CR.17.b

The idea

A collateral agreement is usually documented as a Credit Support Annex (CSA) to the ISDA Master Agreement. The credit support amount is the collateral required, roughly exposure plus any independent amount less the threshold. The threshold is the unsecured exposure one side tolerates before collateral is called. The minimum transfer amount (MTA) is the smallest call that will actually be made, to avoid operational noise. Rounding forces transfers to a set multiple, with delivery amounts rounded up and return amounts rounded down. Eligible collateral and credit quality are set in a schedule, with haircuts that cut each asset's value to protect against price moves. The independent amount (initial margin) is posted regardless of current exposure. A common mistake is treating threshold and MTA as the same thing. Together they set the maximum unsecured exposure.

Formulas

Largest exposure left without a call

Maximum unsecured exposure = K + MTA

K
the pledgor's threshold
MTA
the minimum transfer amount

An approximation that ignores the margin period of risk and rounding. A call is made only once exposure less the threshold reaches the MTA.

Market value of securities needed after a haircut

Market value to post = required ÷ (1 − h)

required
the collateral value needed after haircut
h
the haircut, as a decimal

Divide by one minus the haircut; multiplying the requirement by one plus the haircut understates what must be posted.

A practice question

From the question bank, with the reason each wrong option is wrong.

In a CSA, the threshold is best defined as:

  1. Exposure one party leaves uncollateralised before the other may call for collateral - correct
  2. The percentage reduction applied to the market value of posted securitiesWhy not: This describes a haircut.
  3. The smallest collateral transfer that either party may demand in any one margin callWhy not: This describes the minimum transfer amount, not the threshold.
  4. Collateral that is posted irrespective of the current mark-to-market value of the tradesWhy not: This describes the independent amount (initial margin).

Collateral is only called for exposure above the threshold, so the threshold is the amount of unsecured credit one party extends to the other.

A harder one

A pledgor must deliver collateral worth USD 23.0 million after haircuts. It posts government bonds carrying an 8% haircut. What market value of bonds must be posted, closest to?

  1. USD 21.16 millionWhy not: Multiplies the requirement by 0.92, which shrinks the amount posted instead of grossing it up.
  2. USD 25.00 million - correct
  3. USD 21.30 millionWhy not: Divides by 1.08, applying the haircut as an increase instead of as a reduction.
  4. USD 24.84 millionWhy not: Multiplies by 1.08; the haircut reduces market value, so it must be divided by (1 - 0.08), not multiplied by 1.08.

Collateral value = market value x (1 - 0.08), so market value = 23.0 / 0.92 = USD 25.00 million.

The hardest tier

Exposure is USD 8 million. Structure X has a threshold of USD 3 million and no independent amount. Structure Y has a zero threshold and a USD 3 million independent amount held by the secured party. Ignoring the minimum transfer amount and rounding, how much more collateral does the secured party hold under Y than under X?

  1. USD 11 millionWhy not: Reports total collateral held under Y rather than the difference between Y and X.
  2. USD 3 millionWhy not: Counts only one of the two effects: the threshold or the independent amount, not both.
  3. USD 0Why not: Assumes the threshold and the independent amount offset each other; they both move collateral in the same direction here.
  4. USD 6 million - correct

Under X collateral = 8 - 3 = 5. Under Y collateral = 8 + 3 = 11. Difference = USD 6 million. The threshold cuts collateral while the independent amount adds to it.

In the app: 6 practice questions on this outcome, spaced review that brings it back before you forget it.

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