CDP Documentation & Clearing Infrastructure 2 — Questions and Answers
Question 1: The Credit Support Annex (CSA) primarily governs which aspect of an OTC derivatives relationship?
- The payment of option premiums at trade inception
- The posting and return of collateral to mitigate credit exposure (Correct answer)
- The settlement procedure for physically delivered contracts
- The reporting of trades to regulatory trade repositories
Correct answer: The posting and return of collateral to mitigate credit exposure
The CSA establishes the terms under which counterparties exchange collateral (margin) to reduce the credit exposure arising from mark-to-market fluctuations in OTC derivatives portfolios.
Question 2: In a CSA, the 'Independent Amount' is functionally equivalent to:
- Net current exposure after portfolio netting
- Initial margin covering potential future exposure (Correct answer)
- Variation margin reflecting daily mark-to-market changes
- The threshold below which no collateral transfer is required
Correct answer: Initial margin covering potential future exposure
The Independent Amount is posted upfront to cover potential future exposure, similar to initial margin, and does not fluctuate with daily mark-to-market changes.
Question 3: 'Variation Margin' under a CSA is exchanged to cover:
- Changes in the current mark-to-market value of the derivatives portfolio (Correct answer)
- Potential future exposure over the remaining life of outstanding trades
- Fixed transaction costs and brokerage fees for each trade
- Regulatory capital charges imposed on the dealer counterparty
Correct answer: Changes in the current mark-to-market value of the derivatives portfolio
Variation margin is transferred daily to cover current mark-to-market losses, ensuring that credit exposure is continuously reduced to near zero.
Question 4: A 'Threshold' in a CSA represents:
- The maximum amount of collateral that can be posted at any one time
- The exposure level below which no collateral transfer is required (Correct answer)
- The minimum size of a single collateral transfer
- The haircut percentage applied to non-cash collateral assets
Correct answer: The exposure level below which no collateral transfer is required
The Threshold functions as an unsecured credit limit; collateral is only required when exposure to the counterparty exceeds this agreed level.
Question 5: Under the BCBS-IOSCO margin requirements for uncleared OTC derivatives, which counterparties are mandated to exchange both initial margin and variation margin?
- Only end-users with documented hedging needs
- Financial entities above specified aggregate notional thresholds (Correct answer)
- Sovereign wealth funds and central banks only
- All counterparties to any OTC derivative regardless of size
Correct answer: Financial entities above specified aggregate notional thresholds
BCBS-IOSCO rules phase in requirements based on a firm's aggregate average notional (AANA), mandating both IM and VM exchange for financial counterparties above specific thresholds.
Question 6: A 'haircut' applied to non-cash collateral in a CSA means that:
- The collateral's market value is discounted for margin credit purposes (Correct answer)
- A fee is charged for each business day the collateral is held
- Interest accrues on the posted collateral at the haircut rate
- The collateral must be returned after a maximum holding period
Correct answer: The collateral's market value is discounted for margin credit purposes
A haircut reduces the eligible value of non-cash collateral (e.g., government bonds) below its market price to account for price volatility and liquidity risk during a potential close-out.
Question 7: The 'Minimum Transfer Amount' (MTA) in a CSA is primarily designed to:
- Avoid operational burdens from very small collateral calls (Correct answer)
- Set the maximum collateral transferable on any single business day
- Define which currencies are eligible as collateral
- Limit the rehypothecation of posted collateral assets
Correct answer: Avoid operational burdens from very small collateral calls
The MTA establishes a floor below which collateral calls are not made, reducing the operational cost and friction of managing very small margin transfers.
CDP Documentation & Clearing Infrastructure 2
The Credit Support Annex (CSA) primarily governs which aspect of an OTC derivatives relationship?