Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

14.2 OIS Discounting

14.2.1 The Impact of CSAs

Collateral arrangements involve parties posting cash or securities to mitigate counterparty risk, usually governed under the terms of an ISDA Credit Support Annex. The typical frequency of posting is daily and the holder of collateral pays a (typically overnight) interest rate such as EONIA or Fed Funds. The use of collateral has increased steadily as the OTC derivatives market has developed. The 2010 ISDA margin survey reports that 70% of net exposure arising from OTC derivatives transactions is collateralised. A CSA converts some (but not all, as seen in Section 9.7) of the underlying counterparty risk into funding liquidity risk, as we shall describe in more detail below.

When a counterparty does sign a CSA then the type of collateral is important. As Table 14.1 illustrates, the type of collateral must have certain characteristics to provide benefits against both counterparty risk and funding. Firstly, in order to maximise the benefits of counterparty risk mitigation, there should, ideally, be no adverse correlation between the collateral and the credit quality of the counterparty which represents wrong-way risk. A sovereign entity posting their own bonds, especially if they are short-dated, provides an example of this.² Note that adverse correlations can also be present with cash collateral: an example would be receiving euros from European sovereigns or European banks. A second important consideration is that, for collateral to ...