There and Back Again: Eliminating the Absurdity & The Risk of Offsetting Cashflows and Margin Flows

The standard Credit Support Annex format was drafted long before the financial crisis, and paid little attention to the credit risk created by the time gap between the payment of a large cashflow, and the payment of a reciprocal margin flow to update the collateral for the post-cashflow exposure. With today’s heightened awareness of the counterparty credit risk and margin requirements, the absurdity and the risk of sending a large sum of money to a counterparty only to receive the equivalent amount of collateral back a few days later - that is, if they do not default in the meantime - is finally coming into focus. We will discuss the CSA terms that give rise to this risk, its surprisingly large magnitude, and how it can be mitigated through the use of payment-versus-payment (PvP) services to exchange margin flows.