Posted in Finance, Accounting and Economics Terms, Total Reads: 503
Definition: Credit Support Annex
A credit support annex gives credit protection by forming the rules governing the mutual posting of collateral. Credit Support Annex are used in documenting collateral arrangements between two parties that trade privately without the intervention of any intermediaries negotiated (over-the-counter) derivative securities. The trade is documented under a standard contract called a master agreement, developed by the International Swaps and Derivatives Association (ISDA). The two parties must sign the ISDA master agreement and execute a credit support annex before they trade derivatives with each other. It ensures that there are no conflicts between the trading parties and some uniformity can be maintained.
Each issuer must also obtain an opinion from its respective legal counsel about whether both parties can enter into swap transactions. Issuers must also ensure that such contracts are binding and enforceable, and obtain final credit approval from a bank. Once the party get into the trade, the contract stands binding.
Credit Support Annex is a document that lists down the rules that shall govern the agreement between two parties involved in a transaction. It is used in Over the Counter (OTC) type of trading where there is no involvement of any kind of Intermediaries. The document is prepared under a standard contract that is termed as Master Agreement. This Master Agreement is made by the International Swaps and Derivatives Association (ISDA).both the parties that are getting into a transaction have to mandatorily sign this Master Agreement.
This is primarily used when it comes to derivative trading. It gives credit protection to the concerned parties and also protects them from any kind of cheating or forgery. The main components that are included in this agreement are:
• The Threshold Amount
• Frequency of checking
• Collateral that is eligible for the contract (underlying security for the derivative)
• Minimum transfer amount in case of M2M profit/loss
A firm has started a 5yr INR/USD inter-currency swap with a bank, in which the bank pays a fixed USD coupon and the Corporate pays a fixed INR coupon. The swap has the following terms :
• Threshold Amount: Rs. 5.0 mln
• Frequency: weekly
• Collateral: INR cash only
• Minimum Transfer Amount: INR 1 mln
1. On day 1 the mark-to-market (M2M) of the swap is zero, but after one week it rises to +Rs. 6.5 mln for the bank. The M2M is more than the defined Threshold Amount, so collateral amount equal to Rs 1.5 mln needs to be provided by the firm.
2. After 5 weeks the mark-to-market increases to Rs 7.0 mln.
• As the change in mark-to-market (Rs. 0.5 mln) is less than the Minimum Transfer Amount (Rs.1.0 mln), no more margin collateral needs to be paid by the firm.