ISDA has published a new Standard Credit Support Annex (SCSA) in an effort to standardise market practices in collateral management for over-the-counter (OTC) derivatives. A Credit Support Annex, or CSA, is a legal document which regulates the provision of credit support (collateral) for derivative transactions. It is one of the four parts that make up an ISDA Master Agreement.
ISDA originally announced its intention to develop a standard form of CSA in November 2011, as part of its ongoing efforts to produce more standardised derivatives documentation. ISDA believes the SCSA simplifies market processes regarding collateralisation by promoting consistent and transparent valuations, while making assignment and risk transfer in the bilateral and cleared space more efficient.
The SCSA removes the embedded optionality in the existing CSA, promotes the adoption of overnight index swap discounting and aligns the mechanics and economics of collateralisation between the bilateral and cleared OTC derivative markets. In addition, the SCSA seeks to create a homogeneous valuation framework so as to reduce the current barriers to resolving novations and valuation disputes.
The SCSA retains the operational mechanics of the current CSA but amends the collateral calculation methodology so that derivative exposures and offsetting collateral are grouped into like currencies, or “silos”. The SCSA contemplates that only cash can be used as eligible collateral for variation margin (securities will still be permitted for initial margin). Each currency silo is evaluated independently to generate the required movement of collateral in the relevant currency so as to align bilateral collateral structures and economics, to be more consistent with margin approaches adopted by global clearing houses.
To avoid cross-currency risk, a new net settlement process has been deployed alongside the SCSA: the Implied Swap Adjustment methodology. This process enables parties to net various silo collateral flows into a single payment with a single currency. To achieve net settlement, a common set of standardised market rates is required, including overnight interest rates and the Bloomberg-ISDA SCSA rates for FX, which serves as the foundation for the Bloomberg-ISDA SCSA fixing (SCSA rate). The SCSA rate can then be used by investors to determine collateral and margin requirements between counterparties across multiple currencies.
The SCSA is intended to operate alongside the existing CSA, with market participants having the option of adopting the new SCSA or continuing to use the current CSA. The current CSA is available as an English law CSA and a New York law CSA.