On November 3, 2011, the International Swaps and Derivatives Association (ISDA®) released a presentation outlining its plans for a new Standard Credit Support Annex (SCSA) that is intended to align the collateral mechanics and economics of bilateral OTC derivatives with collateralization of cleared derivatives transactions. The initiative highlights ISDA's effort to redefine its role in producing standard derivatives documentation in the context of a global push toward clearing of OTC derivatives. As detailed in a press release, the SCSA would:

The SCSA retains the operational mechanics of the current CSA but amends collateral calculations so that derivatives exposures and their offsetting collateral positions are grouped by currency, each called a currency "silo." Each silo is evaluated independently to generate collateral movement in that currency between the parties.

In an effort to promote global collateralization standards, the SCSA also eliminates the many permutations that parties may elect under the current CSA. ISDA's presentation on the SCSA suggests that the following variables that parties may modify under the current CSA may be fixed and standardized under the SCSA:

Other elements, such as minimum collateral transfer amounts (referred to in ISDA documents as MTA), could also be subject to standardization, possibly based on the identity of the parties. Under the SCSA, only cash is eligible as variation margin collateral. Eligible securities can still be used to cover initial margin requirements (referred to as "independent amounts" under ISDA documentation).

The SCSA is designed to mimic the collateral mechanics at certain major clearinghouses, most notably LCH.clearnet, one of the world's largest clearers of interest rate swaps. ISDA is attempting to spearhead a convergence of global collateralization mechanics to a large extent by importing the collateral system used at these clearinghouses into the bilateral uncleared OTC derivatives market through the SCSA. ISDA is also hoping to influence existing and emerging clearinghouses to adopt SCSA collateral mechanics.

If use of the SCSA were to become pervasive for uncleared derivatives transactions, collateral mechanics for both cleared and uncleared OTC derivatives would become more closely aligned. This would facilitate market efficiency as well as so-called "portability" of positions (transfer of a swap position from one counterparty or clearinghouse to another). It could also facilitate the cross-margining of a party's cleared and uncleared swaps positions.

Collateral matters for cleared derivatives transactions are governed by the applicable clearing agreement and other documentation of the clearinghouse that clears the transaction. With large segments of the OTC derivatives market moving onto exchanges and through clearinghouses as a result of the Dodd-Frank Act and the global move toward clearing, many market participants have anticipated a reduced need for ISDA documentation, particularly the CSA (see Practice Note, ISDA Documents: Overview (US): Clearing Documentation and Use of the ISDA Credit Support Annex). The SCSA represents ISDA's boldest effort to date to maintain its central role in global derivatives documentation.

ISDA acknowledges significant logistical impediments to global adoption of the SCSA, which would require procedural and technological convergence among a wide range of firms. Successful integration of the SCSA into the market would ultimately require adoption of common market infrastructure elements, including:

Because of these issues, ISDA advocates a gradual implementation of the SCSA, allowing firms to "move at the pace they deem appropriate." ISDA does not envision compulsory use of the SCSA at any time. Trades may be moved from the CSA to the SCSA, but not vice versa.

ISDA also notes that the SCSA may not be bilaterally implemented, like the CSA, and states that it will own and operate the market infrastructure required to operate the SCSA. Presumably this will involve setting and reviewing the universal SCSA rates and terms discussed above.

However, it is not clear that the market will see the need for the SCSA. Counterparties may prefer to retain greater flexibility and optionality in their bilateral derivatives collateral matters than would be provided under the SCSA. Many may elect to continue to use the CSA rather than limit their options with the SCSA, despite the ultimate long-term benefits that could be realized from standardization of OTC derivatives collateral mechanics. On the other hand, parties may welcome the simplicity of the SCSA.

ISDA has not yet finalized the SCSA documentation and is currently in the process of resolving certain outstanding points. ISDA has announced it aims to market test the SCSA in the second quarter of 2012. Wider market adoption is anticipated on a gradual basis after that.

For context on this ISDA initiative, including a discussion of the impact of Dodd-Frank on the use of the CSA and other swap documents, see The Dodd-Frank Act: Swap Documentation Checklist.

For information on ISDA derivatives documentation in the US, generally, see Practice Note, ISDA Documents: Overview (US) and in the UK, see Practice note, ISDA documents: overview (UK).

For detailed information on negotiating the ISDA CSA, see Practice Note, The ISDA Master Agreement: Negotiating the ISDA Credit Support Annex (CSA).

To learn about the mechanics of derivatives clearing, see Practice Note, Mechanics of Derivatives Clearing.