What it means
When two parties trade over-the-counter derivatives (privately negotiated contracts such as interest rate swaps), the value of the deal moves every day. At any moment one side is owed money, and the CSA says that the side that is owed can ask for collateral to cover that exposure.
The CSA sets several key terms. The threshold is the amount of exposure allowed before any collateral is needed, and the minimum transfer amount stops tiny, costly transfers.
It also lists eligible collateral, such as cash or government bonds, and haircuts, which are discounts applied to the collateral's value to cover price swings. On each valuation date, usually daily, the parties work out the net value of all trades under the agreement.
The party that is out of the money must deliver collateral covering the amount above its threshold, and that request is known as a margin call. For a non-banker, the practical point is cash and liquidity.
A company that hedges a loan or foreign currency sales with a bank may have to post collateral when the hedge moves against it, so treasury needs a plan for finding that cash at short notice. The CSA comes in different legal forms, depending on the governing law of the contract.
The English law version transfers ownership of the collateral, while the New York law version gives the receiver a security interest over it. Regulation after the 2008 financial crisis also made collateral exchange mandatory for many trades between large institutions.
In some contexts CSA instead means the Canadian Securities Administrators, the umbrella group of Canada's provincial and territorial securities regulators. The setting, usually a derivatives contract or a regulatory notice, makes clear which meaning applies.
In practice
Real-world examples.
Example
A manufacturer hedges a floating-rate loan with a $20,000,000 interest rate swap. Its CSA allows a $2,000,000 threshold, so no collateral moves until the swap loses more than that amount. When rates fall and the loss reaches $3,000,000, the bank calls for $1,000,000 of collateral.
Example
An airline hedges fuel prices with a bank and agrees a one-way CSA, where only the airline posts collateral. When oil prices fall, the airline's hedge loses value and it must send cash to the bank. The treasurer keeps a credit line ready to fund these calls.
Example
A pension fund enters currency swaps with two banks and agrees a daily-valuation CSA that accepts only cash and government bonds. Its operations team runs a morning report that shows the exposure to each bank. Collateral is sent or returned before the end of the day.
Formula
Calculation
Collateral call = net exposure - threshold, provided the result is at least the minimum transfer amount. Market value of collateral to post = collateral call / (1 - haircut).
Suppose a manufacturer owes a bank $3,400,000 on a set of currency hedges. The threshold is $1,000,000 and the minimum transfer amount is $250,000. The collateral call is 3,400,000 - 1,000,000 = $2,400,000, which is above the minimum, so the call is valid. If the manufacturer posts government bonds with a 4% haircut, it needs bonds worth 2,400,000 / (1 - 0.04) = 2,400,000 / 0.96 = $2,500,000. Check: 2,500,000 x 0.96 = $2,400,000.Case study
Seen in the real world.
This fictional story is illustrative only. Kestrel Foods is an invented food distributor that hedges its European supplier payments with a forward contract (an agreement to exchange currency at a fixed rate on a future date) from a bank.
The first contract it signs includes a CSA with a zero threshold, and the finance team does not read the detail. When the currency moves sharply, the bank calls for $400,000 of cash within one business day, and Kestrel has to draw on an overdraft to pay. Afterwards the treasurer negotiates a new CSA with a $1,000,000 threshold and adds a collateral forecast to the monthly cash plan, so future margin calls no longer come as a surprise.
Watch out
Common mistakes.
- Treating the CSA as boilerplate. Its threshold and collateral terms decide how much cash you may have to find at short notice.
- Forgetting the haircut. Posting collateral worth exactly the call amount can leave you short once the discount is applied.
- Assuming collateral calls only happen in a crisis. They can occur on any day the hedge moves enough to cross the threshold.
Questions
People also ask.
Is a CSA the same as an ISDA Master Agreement?
No, the CSA is an annex that sits under the master agreement and deals only with collateral.
Who pays the margin call?
The party whose side of the net trades is losing value, once the amount exceeds its threshold.
Can a CSA be one-way?
Yes, in a one-way CSA only one party posts collateral, which is common where one side has much stronger credit.
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