ISDA AND COLLATERALIZATION: STRENGTHENING SECURITY IN DERIVATIVE MARKETS

The practice of collateral management has existed since the 1980s when Bankers Trust and Salomon Brothers began taking collateral against credit exposure. Derivative collateralization became more prevalent in the 90s, which led to the development of standardized rules by the International Swaps and Derivatives Association in 1994. Credit Support Contracts or collateralization provide protection for the derivative contract itself. By setting aside collateral which is marked to margin, if any of the parties’ default, then the collateral becomes protection for the non-defaulting party. This is different from using derivatives to protect from external risks. Collateralization protects the parties from the risk of default of either party to perform their individual contractual obligations. There are different levels of risk protection in derivatives contracts, first is the risk protection from a counterparty’s general market exposure (such as interest rate risk or currency risks) and the second is the risk protection against default or bankruptcy of a party or parties flowing from the immediate derivatives transactions. This article does an exposition of the ISDA collateralization structure. It is aimed at ensuring an understanding standard security taking mechanisms adopted in derivatives transactions. The focus of this article is on the 1995 English Law Credit Support Annex and the 1995 English Law Credit Support Deed.