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Spell out what a collateralization agreement typically contains.

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

The idea

A collateralization agreement, normally a CSA under an ISDA Master Agreement, contains the commercial terms for margining. It names the parties and base currency, sets the threshold, minimum transfer amount, rounding and any independent amount for each party, lists eligible collateral and the haircut on each asset and currency, and fixes the valuation agent, valuation and notification times and settlement timing. It also covers interest on cash collateral, the right to substitute collateral, the right to reuse or rehypothecate it, custody arrangements, how disputes are resolved, and what happens at default or termination, including rating triggers. The governing law decides whether the structure is a pledge or title transfer. It does not hold trade economics, which stay in confirmations. For the exam, know the list and what each term does.

A practice question

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

Which of the following would NOT normally be set out in a CSA?

  1. The interest rate paid on cash collateralWhy not: This is a standard CSA term, so it is not the exception.
  2. The valuation agent and the notification timeWhy not: These are standard CSA terms, so this is not the exception.
  3. The fixed rate and notional of each individual swap - correct
  4. The haircut applied to each eligible collateral typeWhy not: Haircuts are a standard CSA term, so this is not the exception.

Trade economics belong in confirmations; the CSA covers collateral mechanics such as haircuts, valuation and interest.

A harder one

Which CSA term fixes the time of day by which a margin call must be received for the transfer to settle on the standard timetable?

  1. The valuation dateWhy not: The valuation date is the day values are measured, not the cut-off time for demands.
  2. The rounding amountWhy not: Rounding sets the multiple in which collateral is transferred, not a time.
  3. The thresholdWhy not: The threshold is an amount of unsecured exposure, not a time.
  4. The notification time - correct

A demand made after the notification time is treated as made on the next business day, so the term controls settlement timing.

The hardest tier

Four CSA packages are compared. Ignoring the margin period of risk and rounding, which gives the smallest maximum uncollateralised exposure before a call is triggered?

  1. Threshold zero, minimum transfer amount USD 1.5 millionWhy not: Picks the zero threshold as safest, but a 1.5 MTA alone leaves 1.5 uncollateralised, more than 1.25.
  2. Threshold USD 1.0 million, minimum transfer amount USD 0.25 million - correct
  3. Threshold USD 0.75 million, minimum transfer amount USD 0.75 millionWhy not: Assumes balanced terms are best; the sum is 1.50, above 1.25.
  4. Threshold USD 3.0 million, minimum transfer amount USD 0.1 millionWhy not: Ranks on the smallest MTA alone; the 3.0 threshold dominates, giving 3.1.

Maximum unsecured exposure is about threshold + MTA: 1.50, 1.25, 1.50 and 3.10 respectively. The package with a USD 1.0 million threshold and USD 0.25 million minimum transfer amount is lowest.

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