What is a Credit Support Annex (CSA)?

A credit support annex (CSA) is a document that defines the terms for the provision of collateral by the parties in derivatives transactions. It is one of four parts of a standard contract or master agreement developed by the International Swaps and Derivatives Association (ISDA).

ISDA master agreements are required between any two parties trading derivative securities in a privately-negotiated or over-the-counter (OTC) agreement rather than through an established exchange. The majority of derivatives trading is done through private agreements.

[Important: Because of the high risk of losses on both sides, derivatives traders generally provide collateral as credit support for their trades.]

How a CSA Works

The main purpose of a CSA is to define and record the collateral offered by both parties in a derivatives transaction in order to ensure that they can cover any losses.

Derivatives trading carries high risks. A derivatives contract is an agreement to buy or sell a specific number of shares of a stock, a bond, an index, or any other asset at a specific date. The amount paid upfront is a fraction of the value of the underlying asset. Meanwhile, the value of the contract fluctuates with the price of the underlying asset.

In fact, OTC derivatives are riskier than derivatives traded through exchanges. The market is less regulated and less standardized than exchange markets.

OTC derivatives are often traded as a speculation. They also are traded as a hedge against risk. As such, many major corporations engage in derivatives trades in order to protect their businesses against losses caused by currency price fluctuations or sudden changes in raw materials costs.

Why Collateral Is Required

Because of the high risk of losses on both sides, derivatives traders generally provide collateral as credit support for their trades. That is, each party sets aside collateral as a guarantee that it can meet any losses.

Collateral, by definition, can be cash or any property of value that can be easily converted to cash. In derivatives, the most common forms of collateral are cash or securities.

In derivatives trading, the collateral is monitored daily as a precaution. The CSA document defines the amount of the collateral and where it will be held.

ISDA Master Agreement

A master agreement is required to trade derivatives, although the CSA is not a mandatory part of the overall document. Since 1992, the master agreement has been used to define the terms of a derivatives trade and make them binding and enforceable. Its publisher, the ISDA, is an international trade association for participants in the futures, options, and derivatives markets.

Key Takeaways:

  • A CSA is part of a contract agreement required for any privately-negotiated derivatives trade.
  • This document defines the terms of the collateral put up by both parties to the transaction.
  • Collateral is normally required because of the high risk of losses associated with derivatives trading.