What is a Credit Support Annex
A credit support annex (CSA) provides credit protection by setting forth the rules governing the mutual posting of collateral. CSAs are used in documenting collateral arrangements between two parties that trade privately 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).
BREAKING DOWN Credit Support Annex
Parties must sign an ISDA master agreement and execute a credit support annex if appropriate before they trade derivatives with each other.
The main purpose of a credit support annex (CSA) is to regulate the collateral held by two parties entering into an ISDA master agreement. The collateral helps to ensure efficient support by mitigating insolvency risks and potential losses associated with the derivative trades. The CSA is one of various parts of an ISDA master agreement.
ISDA Master Agreement
ISDA master agreements are required between the parties trading over-the-counter derivative securities. The ISDA master agreement is a document provided by the ISDA which can be amended to customize terms for two trading parties. The two parties must agree to the terms and sign the ISDA master agreement before trading.
The majority of the ISDA master agreement typically includes a boilerplate master agreement section provided for by the ISDA. Other aspects of the agreement typically include a master agreement schedule, confirmation and the credit support annex. Credit support provisions included within the credit support annex portion of the agreement are optional however often used by most trading parties to provide credit support and protect the parties from losses.
In addition to agreeing upon credit support annex terms and executing the ISDA master agreement, issuers must implement proper resolutions giving authorization to complete derivative transactions. 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.
Credit Support Annex Collateral
Over-the-Counter (OTC) derivatives can carry high risks, primarily because their value is derived from an underlying security which causes the value of the derivative to fluctuate substantially. Since over-the-counter derivatives do have high risks, parties who trade them often seek collateral as credit support for the trades. The requirements for collateral are outlined in the credit support annex included within the ISDA agreement. Collateral needed for credit support is monitored daily.
Collateral amounts must be sufficient as outlined in the credit support annex before a trade can be completed. Collateral can often take many forms with the most common being cash or securities. Requirements for collateral levels must constantly be monitored in order to ensure that adequate collateral is held per OTC derivative trading value.