ISDA working group close to finalising standard CSA

Dealers are close to agreeing a final template for a new standard credit support annex (CSA), having made some significant changes in recent months in response to industry concerns.

The new document, being drawn up by an International Swaps and Derivatives Association working group, is meant to eliminate the embedded optionality in the existing CSA, which has led to a number of valuation disputes and caused novations to virtually slow to a halt. It does so by establishing 17 currency silos, in line with the currencies cleared by London-based clearing house LCH.Clearnet.

The idea is that every trade would be allocated to one of those 17 silos, the counterparty would post cash collateral in that currency, and the trade would be discounted using the relevant overnight indexed swap (OIS) rate or – if a liquid OIS curve doesn’t exist – an agreed alternative. So, a dollar-denominated swap would be allocated to the dollar silo, and the two counterparties would post dollar cash for the trades within that bucket. The federal funds rate would then be used to discount those transactions.

This is a significant change from earlier proposals, which included just five silos, corresponding to those currencies with liquid OIS curves: dollar, euro, yen, sterling and Swiss franc. OIS is theoretically the correct discount rate for cash-collateralised trades, as it is used to determine the interest rate paid on cash collateral. Expanding the number of silos means alternative discount rates will need to be agreed for silos six to 17, at least until liquid OIS curves develop in those markets.

However, this approach is already employed by LCH.Clearnet, and dealers are keen to ensure the methodologies for cleared and uncleared trades mirror each other, eliminating any mismatch that might occur between a bilateral transaction under the standard CSA and a cleared hedge.

For instance, under earlier proposals, a Norwegian krone trade might have been allocated to the euro silo under the standard CSA, requiring collateral to be posted in euro cash, with the euro overnight index average rate used to discount the transaction. However, it is likely a hedge conducted with an interdealer counterparty would be cleared through LCH.Clearnet, requiring Norwegian krone cash to be posted as collateral, with a local Norwegian krone Libor-style curve used to discount the trade.

“If you are not using the Group of 17 (G-17) currency silos in the bilateral context, your Norwegian krone swap with the client would be collateralised in, say, euro, but the hedge would require Norwegian krone to be delivered if it is cleared through LCH.Clearnet, so there’s cross-gamma risk there,” says one source close to the Isda working group.

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