The Jolly Contrarian on ISDA

The Jolly Contrarian

Diving into the wellspring of that is the ISDA Master Agreement jollycontrarian.substack.com

Episodes

  1. FEB 13

    Variation margin: deep history Pt 2

    Thanks for reading! This post is public so feel free to share it. This is part 2 of an essay. Here is variation margin: deep history part 1. There will be a third. Refresher Prompted by the simple question “why do Americans prefer collateral pledges and Brits prefer title transfer collateral?” we were talking last time about the difference, in the JC’s argot, between “collateral” on one hand and “security” on the other. In this sense, “collateral” is something you give bodily over to your creditor. “Security” is an enforceable legal promise you make over assets you keep hold of yourself. These are quite different modes of performance assurance. They have different effects when it comes to doing the two things any lender cares about: managing the debtor’s credit risk and managing the creditor’s cost of funding the debt. Another quick definition pit-stop: I sometimes refer to “borrowers” and “lenders” here, but more properly I should say “creditor” and “debtor”, because the same principles apply whether you have extended a formal “loan” or you are simply owed money under some other credit arrangement. A swap, for example, is not a formal loan, but any mark-to-market exposure under a swap, economically, is the same as a loan: specifically, like an overdraft, with a fluctuating balance accruing interest at a floating rate. Now, since, when discussing loans, most lawyers rarely think past credit risk, we spoke a bit about the seldom discussed but vital, business of funding optimisation. We will do a bit more of that in this episode. Along the way we will encounter Shylock, Spinal Tap, the Osmonds, the widow Herring, a nice fish restaurant overlooking a beautiful lake in the Ostallgäu and a resourceful young private in the house band of the 101st Airborne by the name of James. Dans une coquille de noix In part two of this essay I will trace the development of financial collateral from pure credit mitigation — from no collateral to customary liens to pawnbroking arrangements — to modern margin arrangements which introduce an important new feature: funding cost management. How can a creditors use collateral posted them to offset or optimise their costs of funding their exposure? For most of history, security interests and even possessory collateral served only the purpose of credit protection. Funding management couldn’t come into it because the assets involved were unique, illiquid, or both. The creditor was obliged, therefore to just sit on them. But just sitting on productive assets and not using them is a cost and a missed opportunity in any business. Finance is no different. We will see how as fungible, liquid financial instruments emerged in the 19th century, institutional creditors began to monetise their collateral portfolios, converting them, temporarily, into cash. The modern derivatives market developed out of that capability. Though we started looking purely at collateral arrangements established to offset the risks and costs of extending credit, we will pause to notice how these arrangements resemble, very closely, other kinds of financial transaction in the market place. There is a sort of fractal similarity here. This idea of funding optimisation is embedded in every aspect of the financial markets. But let’s not get ahead of ourselves. Let’s start at the beginning. There’s a good play about this. Play the movie. Ja. Play. Collateral as a credit tool A pound of flesh? Shylock: But ships are but boards, sailors but men; there be land rats and water rats, water thieves and land thieves—I mean pirates—and then there is the peril of waters, winds, and rocks. The man is, notwithstanding, sufficient. Three thousand ducats. I think I may take his bond. The Merchant of Venice, I, iii Shylock, you may remember, could not take collateral, or security, but had only Antonio’s word as his bond: Antonio was, in the vernacular, “expectation-rich, but asset-poor”: all his worldly possessions were out and about, on the water, in pursuit of riches but at the mercy of the land rats and water thieves of the seven seas. Shylock was right to have been worried. It all went horribly wrong for Antonio as buccaneers on the high seas laid low his assurances. It hardly worked out any better for Shylock — xenophobia and the finer points of Venetian contract law — did for his, but at least drama fans got a pleasant evening out if it. But all this — well, drama — for the want of tangible performance assurance. The famous “pound of flesh” is a kind of security, but it is not “collateral”. We could, therefore, regard The Merchant of Venice as a morality play about the danger of uncollateralised lending. But collateralised lending goes way back before Shakespeare’s time, of course. Collateral 101: credit risk From the dawn of history — as Nigel Tufnel might say, hundreds of years before that — private lending arrangements have involved credit risk. That is their fundamental wager: I lend you money; you spend it. I hope you are wise enough, and honest enough, to give it back. The amount a debtor pays for the privilege of obtaining credit represents two things: the “time value” of the money borrowed — the opportunity cost of extending credit to this debtor and not using the money for something else — and a “credit spread”: a “premium” representing the creditor’s assessment of the risk the debtor won’t pay it back. Whether a debtor repays depends firstly, on its honesty and secondly its solvency: its general business acumen over the period of the loan. This is a matter of a creditor’s personal faith: credit is, literally, latin for “he believes”. Credit risk is not hard to get your head around, and lawyers spend an awful lot of time worrying about it. Traditionally, there are three ways to manage it: by taking “security”, by taking “collateral” or by obtaining “sureties”. A quick reminder: I treat these three concepts as mutually exclusive in a way that does not really reflect common usage. Lawyers are oddly casual in their terminology here. Security Creditors can take security — the debtor grants the creditor abstract legal rights over some of its assets, but continues to hold and use those assets. For example, a mortgage. The debtor lives in the house, but if she does not keep up her payments, the creditor can turf her out and sell it to recover its debt. Collateral Creditors can take collateral — the debtor physically delivers assets to the lender for safekeeping, as a bond against repayment. For example, a pawnbroking arrangement. The pawnbroker holds your asset until you repay your loan, and can sell it if you don’t. Sureties Creditors can take sureties — a trusted third party underwrites the debtor’s obligation to the creditor. A guarantee or a letter of credit. I mention sureties for completeness: I am not going to dwell on them as they aren’t really practical funding mitigants. I don’t want to get ahead of ourselves, but in the 19th century creditors began to look for ways to reduce the absolute cost of money they were lending, and wondered whether their credit mitigation arrangements might help. Physical collateral: liens and pledges Taking physical collateral against a debt obligation is as old as civilisation. Its simplest, most customary form is the lien. Liens Liens are “customary” in the sense that they did not grow out of some brilliant legal innovation but were an existing cultural practice that the law simply recognised. A lien is the original “self-help remedy”: oh, you want your watch back? Pay your bill. Possession is nine-tenths of the law. Liens are all about possession. They arise automatically and without formality: when you take your car in for a service, the mechanic can hold onto it until you have paid your bill. Say, after an agreeable meal at the delightful Fischerhütte in Hopfensee, you are caught short. The proprietor points to your watch as a condition to letting you out the door. This is mostly an honesty play, rather than a solvency one: what matters isn’t the watch’s realisable value so much as its value to you, and the hassle of having to replace it. Herr Fischer has very little interest in selling your watch: he is in the business of serving up Zanderfilet mit frischen Kräuter-Rahmschwammer rather than hocking off collateral to settle his debts: he just wants his punters to enjoy their perch and pay their bill. It is very good by the way. Primarily, liens are a practical lever to make sure debtors do the right thing. They are an assurance mainly, of honesty. They not a great mechanism for recovering debts if they don’t. Hence — as with a mechanic’s lien over your car — the collateral value is often out of all proportion to the debt. The practical value of a lien is its awkwardness. Even a bankruptcy administrator will find it financially expedient to settle the lienholder’s bill — or walkaway altogether — than challenge the effectiveness of a lien. We can see here the power of sentimental value. It brings the borrower back to the table regardless of any rational assessment of value the collateral. But you can take it a bit far: The original human shield A quick amusing sidebar, for which I am indebted to regular correspondent Mr. Johnston, who is a bottomless source of such ribaldry: the old case of Herring v Boyle (1834) 1 CM&R 378. It concerns a schoolmaster, Boyle, attempting to extract school fees from a widow, Mrs. Herring, for the education of her 10-year-old son. On Christmas Eve Mrs. Herring arrived at Mr Boyle’s school to collect her lad for the holidays. At the time she was up-to-date with her fees, but a new instalment was due the following day. Fearing he might not see the pair again, Boyle took an imaginative, if idiosyncratic, approach to the situation. In effect, he asserted a lien over the lad. You may have your

    32 min

  2. FEB 6

    SLAPPs, without prejudice and a latter-day Albert Haddock

    A case concerning a snippy letter from a lawyer who should have known better to another one, who did, is an odd departure point for an excursion into without prejudice, but here we are. This is what I would call an “Albert Haddock” case. Albert Haddock was A. P. Herbert’s ornery civilian litigant, always getting himself in trouble, or up the nose of the authority, presenting negotiable cows to the revenue, when on a flooded road arguing that vessels should pass starboard to starboard and so on. Albert Haddock is fictional. His real-life counterpart here is a chap called Dan Neidle. Mr. Neidle should understand I mean “Haddock” in the most reverential way: the JC is a big fan (of both Messrs. Haddock and Neidle). I like people who “poke the Borax” and I have no great fondness for civil litigators. And as we will see, there is nothing quite like a bit of “Neidle needle”. That said, the ultimate outcome of this case, in which Mr. Neidle’s antagonist was exonerated from disciplinary charges sent his way, seems right. We will come to that in good time. First, the facts. Facts In July 2022 Dan Neidle, nowadays something of a public provocateur on matters of tax policy, but for many years Clifford Chance’s head of tax, published some embarrassing allegations about the tax affairs of the then recently-appointed Chancellor of the Exchequer, Nadhim Zahawi. Unwisely — has no-one heard of the Streisand Effect? — Mr. Zahawi “went to the mattresses”. He engaged a firm of solicitors to shut Mr. Neidle up. That firm of solicitors was Osborne Clark. Carriage of the matter fell to one Ashley Hurst, a litigation partner. Mr. Hurst’s first instinct was sensible: he messaged Mr. Neidle suggesting they chat. Mr. Neidle was having none of it. He told Mr. Hurst to put whatever he had to say in writing. Mr. Hurst replied, “Trying to avoid that. We can speak WP [“without prejudice”] if you like.” Again, Mr. Neidle declined. He said, “Please note I will not accept without prejudice correspondence.” Mr. Neidle said this because “without prejudice” communications have a special status in civil litigation. In essence, they cannot be put before the court. Mr. Neidle did not want to cede his right to put anything Mr. Hurst said before the court. “If you are not prepared to say it out loud,” Mr. Neidle implied, “do not say it.” This did not deter Mr. Hurst. He composed a snippy letter he will have since come to regret. Snippy letters are part of the stock-in-trade of civil litigation. Much of it is resolved without resort to much else. Most people back down at the first missive they receive on law firm-headed notepaper. Mr. Neidle is not most people. He is not the backing-down type. Law firm-headed notepaper was not going to cow him: his own name had been on law firm-headed notepaper for many years. He does not frighten easily. He likes a scrap. Mr. Hurst ought really to have known this, from a casual read of the papers. It seems he did not. Mr. Hurst emailed his snippy letter to Mr. Neidle. It was ill-judged in a few respects, but in one especially: it claimed to be “without prejudice and confidential”. It said: It is up to you whether you respond to this email but you are not entitled to publish it or refer to it other than for the purposes of seeking legal advice. That would be a serious matter as you know. We recommend that you seek advice from libel lawyer if you have not done so already. There was no attempt to settle the dispute at all. Mr. Hurst’s letter was not an attempt to stave off litigation, but a veiled threat to embark on it: Should you not retract your allegation of lies today, we will write to you more fully on an open basis on Monday. In the meantime, our client reserves all of his rights, including to object to other false allegations that you have made. I am available to discuss if you change your mind on having a phone call. That could well save time and expense on both sides. Even at this stage, Mr. Hurst held out hope that a phone call might de-escalate things. He hoped in vain. Mr. Neidle gave Mr. Hurst a polite version of what we might call the “Pressdram Salute”. He published Mr. Hurst’s “without prejudice and confidential” letter and, not long afterward, referred Mr. Hurst to the Solicitors Regulation Authority, complaining that Mr Hurst’s use of the “without prejudice” label amounted to, or somehow hinted at, a “strategic lawsuit against public participation”. So-called “SLAPPs”, in which the moneyed and powerful use the legal system to stifle fair enquiry into matters of general public interest, have become a bane of public life in the UK. The SRA has been on the warpath against them. It saw in Mr. Neidle just such a “public participant” and, in Mr. Hurst’s letter, an intolerable attempt to muzzle him on Mr. Zahawi’s behalf. It began an investigation that culminated, 18 months later — no-one could accuse it of precipitate action — in a referral to the Solicitors Disciplinary Tribunal, on the grounds that Mr. Hurst was engaged in an illegitimate SLAPP. Before we get to that, it is worth recounting what happened in the meantime, without the SRA’s intervention. Firstly, Mr. Neidle did not retract any of his allegations, and in fact doubled down on them. Secondly, Mr. Zahawi did not exercise any of his “reserved rights”. None of the veiled threats in Mr. Hurst’s letter came to pass. To the contrary, in January 2023, Mr. Zahawi was reported to have paid a penalty to HMRC. Shortly after that the Prime Minister’s Independent Adviser on Ministers’ Interests identified that he had breached the ministerial code seven times. The Prime Minister sacked Mr. Zahawi from his post as Chancellor of the Exchequer the same month. Within a year, in the face of growing opposition from his own constituency party, he announced he would not stand in the 2024 General Election. That is to say, thanks in significant part to his misconceived attempt to limit Mr. Neidle’s “public participation” Mr. Zahawi’s political career spectacularly imploded. We should take heart from this outcome. It feels like a system working well: hubris is rewarded with nemesis. The cosmos has delivered its own savage justice. In its perverse way, a prominent politician’s freedom to detonate his own reputation seems a positive constitutional safeguard. It is not clear what further action is needed. The Solicitors Regulation Authority did not agree. It came for Mr. Hurst. Two days after the Chancellor’s sacking, the SRA referred him to the Solicitors Disciplinary Tribunal. It accused him of breaching SRA guidance by improperly labelling his correspondence “without prejudice”, “confidential” and “not for publication”, when the conditions justifying those labels were unfulfilled. This seems a rather timid complaint. SRA guidance cautions solicitors not to intimidate or mislead third parties, and to take particular care with the vulnerable or unrepresented, but the SRA’s focus on these formal indicators, rather than the substantive intimidations in the body of the letter, seems rather, well, formalistic. It may be because it seemed a “slam dunk” contravention of SRA guidelines. They specifically call the formal labels out: One way this can happen in this context is by labelling or marking correspondence ‘not for publication’, ‘strictly private and confidential’ and/or ‘without prejudice’ when the conditions for using those terms are not fulfilled. In any case the SDT heard the matter in December 2024 and, in May the following year, handed down its decision. It agreed that Mr. Hurst had acted improperly and fined him £50,000. Mr. Hurst appealed. In January 2026 the administrative decision of the High Court upheld his appeal and overturned the SDT’s finding. In light of the practical resolution of events — Mr. Hurst’s client torching his own political career — and the curiously formalistic approach to the disciplinary breach, this seems the correct outcome. This Substack is reader-supported. To receive new posts and support my work, consider becoming a free or paid subscriber. Without prejudice “Without prejudice” is, in JC’s view, a silly frippery of the civil courts. In seeking to imbue a kind of legal privilege to bona fide settlement offers — a privilege they absolutely do not need — the courts have evolved a fiddly, confusing and self-contradictory cranny of procedural jurisprudence. Rather than regarding them simple markers of a constructive approach to dispute resolution, the court is expected to pretend that formal settlement overtures do not exist. They acquire an odd, mystical, Schrodinger’s cat-type status, though, because — sometimes — they can be presented when it comes to arguing about costs. But that’s as may be, however: the “without prejudice” rules exist and we are stuck with them. So is Mr. Hurst. A key plank in the SRA’s argument was that Mr. Hurst’s communication was no kind of settlement offer, and that therefore labelling it “without prejudice” was improper and intimidating. This idea is implicit in its guidance, quoted above. But this gets things exactly backward: a “without prejudice” label (for whatever reason it is applied!) is the opposite of threatening: it signals a settlement offer. One should be overjoyed to receive a without prejudice letter. The “prejudice” it seeks to avoid is to the interests of the sender. Without prejudice is defensive, not intimidatory. It is a white flag, not a black one. That, indeed, is why the courts developed its silly jurisprudence: to spare the sender’s blushes: to prevent disclosure before court a document which on its face speaks to its author’s weakness. “Without prejudice” seeks to avoid misconstrual as a concession of weakness from the sender, not aggression. The SRA guidance in this regard seems

    32 min
  3. Variation margin: deep history Pt 1

    JAN 30

    Variation margin: deep history Pt 1

    In the worlds before Monkey, primal chaos reigned.Heaven sought order — butThe phoenix can fly only when its feathers are grown.The four worlds formed again and yet againAs endless aeons wheeled and passed.Time and the pure essences of heaven,The moisture of the Earth, the powers of the sun and the moonAll worked upon a certain rock, old as creation, and it becameMagically fertile.That first egg was named, “Thought”.Tathagata Buddha, the Father Buddha, said:“With our thoughts we make the world.”Elemental forces caused the egg to hatch.From it then came a stone monkey.The nature of Monkey was —Irrepressible. — David Weir, Monkey 1978 As JC starts to overhaul the CSA Owners’ manuals I thought it might be nice to take a step back and look at the deep background to collateral as we glom it today. The road is long, and it has its roots in custom and practice in the industrial revolution. There is deep mythology in play, too. I know this because I made it up myself. I was prompted to embark on this by the question: “Why is collateral pledged under New York law CSAs while it is title transferred under English Law ones?” Like so many of the mystic principles of the law, younglings are told this at an impressionable age, expected to absorb it, take it as read, and thereafter not ask impertinent questions about it. JC’s dismal career trajectory might have something to do with asking questions that were impertinent — or stupid — in the supervising partner’s eyes there is little difference. In any case, I asked myself this question and — well you know me, readers — I went and fell right down a rabbit hole, didn’t I? So here is the JC’s deep backgrounder on collateral, security and the role they play in mitigating credit risk and financing costs of lending and financing in modern markets, and why English law variation margin arrangements tend to be by title transfer, and New York ones by pledge. Where the fossil record is incomplete — or I can’t be bothered looking into it — I have followed the time-tested JC tactic of making it up out of whole cloth. This is my truth. Buckle in! This Substack is reader-supported. To receive new posts and support my work, consider becoming a free or paid subscriber. Security & collateral. Credit & funding This is a story about two pairs of concepts: “security” vs. “collateral” and “credit” vs. “funding”. These pairs relate to the business of lending and subtly different, financing. In their way, they help to distinguish between “lending” and “financing”. “Lending” and “financing” is another pair of conjoined, but independent, concepts. It is profound, and resists frontal assault. We can attack it through these proxies. Security vs. collateral The first pair is “security” and “collateral”. Herewith the first JC invention: a clean distinction between them. For the purposes of this essay, and perhaps only for the purposes of this essay: Security is an immaterial legal right—a mortgage, charge, lien, an equitable interest. Collateral is physical possession of a material thing—an asset, delivered to a creditor’s order for safekeeping. You may not find it in Black’s Law Dictionary, but it is a practical distinction. Lawyers tend to use the concepts interchangeably: they fulfil similar roles when it comes to mitigating credit risk, but as we will see, not when it comes to funding. Mainly, lawyers understand credit risk better than they do funding, because credit is the risk something might in the future go wrong, and that is a commercial lawyer’s main preoccupation. But funding is no less — nay, in the round, more — important. But we will get to that. Now, there are collateral arrangements, security arrangements, and those that are both. I wanted to highlight a term here that captures either legal theoretical interests, whether or not also involving possession, and title transfer collateral interests that necessarily do but, as best as I can tell, there isn’t one. I thought it might be “encumbrance”, but that implies a security interest, as does “surety”. I tried “posted”, but that conveys the transfer of possession. The commodities people have a concept of “performance assurance”, but that is too wide. Might this be a rare justification for and/or? I thought that was annoying for a moment but, maybe it is the point. Collateral and security are quite distinct things. They can be, but (in the UK at least) are not often seen in the same room together. You can have a security interest without any collateral (e.g., an assignment by way of security over contractual rights) and you can have a collateral arrangement without a formal security interest (e.g., a title transfer credit support arrangement). And you can have both. The classic case is the lien. TL;DR: Security depends on legal magic to work. Collateral doesn’t. So, that is the first pair of concepts. Security: immaterial rights. Collateral: stuff. Credit vs. funding The second pair is “credit risk” and “funding”. Credit From early in our careers we learn that, when it comes to handing money over to strangers, credit risk is a lender’s most obvious concern. Even lawyers understand it instinctively: will the borrowers be able repay? What are my weapons if they cannot? Where a lender has collateral, there is little fuss. She holds it. She can sell it, claim what’s owed and give whatever’s left back. Other creditors can squabble over that to their hearts’ content. Our heroic lender is away, Scot-free. Where the lender has only security, she is still okay: she can jump the unsecured creditors in the queue and seize secured assets — whereupon they become like collateral, so she can sell them and account for the profits — but to do that she must take formal legal steps, which require a court’s help and are easy to muff up. There is always the risk of challenge by other creditors. If we invert the old saw Security is one tenth of the law. Possession, is the rest. Another difference between security and collateral is who has the use of the assets in the mean time? The lender holds collateral assets. The borrower gives them up at the outset. The borrower holds secured assets. The borrower keeps possession, but is restricted in what it can do. The lender has no right to intervene unless and until it is entitled to “enforce” its security. But this is an action of last resort, taken only with heavy heart and when all hope is lost. Everyone — borrower and lender alike — is fervent in their hope they this day never comes. Usually, it never does: a bankruptcy is a remote possibility: a “tail event”. it happens rarely. But it is catastrophic when it does. Security arrangements where the borrower gets to keep its asset are therefore contingencies: forms of insurance a lender puts in place to guard against extreme events. Collateral arrangements, where the borrower collateralises day one, are not. Another difference — a corollary to the above — is the depth of credit mitigation. The “credit value” of identified collateral is inherently limited to its liquidation value: once it is gone, it is gone. Hence, collateralised obligations tend to be subject to a haircut, regularly “marked to market” and exchanged to ensure there is always a buffer to cover the debt after liquidation. By contrast, a security right against a person is usually unlimited, to the value of the debt, against the person who grants it. You can pursue the guarantor to bankruptcy, if need be, to recover a beneficiary’s debt. On the other hand, “enforcing” against collateral is dead easy: you just sell it. No particular ceremony, though you must be carefully to achieve a fair price in the market. The more liquid your collateral, the easier that is to monitor. But enforcing security interests is elaborate, involves lawyers, courts and frequently bankruptcy administrators. So credit is the assessment of a borrower’s likelihood of repay her debt. “Credit risk mitigation” is anything a lender does to improve that likelihood in the event of the borrower’s failure. Security interests and collateral arrangements both mitigate credit risk. Funding Funding is the business of finding the money with which a lender makes a loan in the first place. Lending institutions need reliable funding sources: those may be their own customer deposits, separate banking facilities, or medium term note and commercial paper programmes and the bank’s repo and securities lending arrangements, whereby it “lends out” its inventory of securities held for investment, as hedges and as collateral in connection with its customer trading business. This unglamorous but important business — making sure there is enough money available to lend, and at good rates, to whoever wants to borrow — falls to the bank’s treasury department. Wherever it comes from, money — “funding” — comes at the cost of the interest the bank must pay on it. A bank will do whatever it can to reduce its “cost of funding” and broaden its sources of funding. A day one cost Unlike credit risks, funding costs are remote contingency that everyone hopes will never happen. They are a fundamental input cost to the business of providing loans. Optimising funding costs can dramatically boost a bank’s overall performance. Getting it wrong can, in rare cases, be catastrophic — the classic example is Silicon Valley Bank — but in any case, managing funding is not a “once in a blue moon”, tail-risk sort of thing. It matters on every loan on every day. The imperatives of funding optimisation, therefore, have quite different implications for the kind of security or collateral involved. Though collateral and security interests both address the credit risk, only possessory collateral is any use in managing its funding costs. Security ⇒ credit.Collateral ⇒ funding. Forma

    32 min

  4. JAN 23

    Credit Support Annex: Preamble

    This is a free preview of a paid episode. To hear more, visit jollycontrarian.substack.com This is going to be quite the epistolic journey. Like a Dickens novel designed for people with no taste in literature and an unusually high threshold for pain. I have started to refresh the CSA pages. As I go I am going to put out newsletters and podcasts. Here is the first once. Premium subscribers: the premium version of the podcast covers all the economy material, too. You don’t need to — but are fully welcome to! — listen to them both. Eco-subscribers: for the price of half a pint of alcohol-free beer at the JC’s local every week, you too could have all the extra jokes, analysis and nasal mumbling that the Premium subscribers get. Sign up to the premium substack, and you get automatic access to the premium JC This Substack is reader-supported. To receive new posts and support my work, consider becoming a free or paid subscriber. The preamble to ISDA’s CSA On preambles, weapons in Russian plays, etc. The “preamble” is the throat-clearing passage of a commercial legal document: the scene-setter that puts you in the right place, the right frame of mind, and gives you a non-spoiling sense of what is coming. It is the warm-up question on Millionaire, designed to settle an anxious contestant down, so you might expect there to be little more to say about it. Now occasionally a preamble might introduce a key fact into the narrative — a kind of “Chekhov’s gun” that the reader must mark, bear in mind, make mental note of, and prepare for its discharge in the third act. The preamble to ISDA’s suite of Credit Support Annexes is no exception. There are not one, but now seven: the first was released to the Americans in 1994, a couple followed for the Brits in 1995, and four more came with the algal bloom of margin regulation in the latter half of the 2010s. The different CSA varieties have different preambles casually mentioning different firing irons fixed to the wall over the fireplace. So what is all that about, then? Credit Support Document or Transaction? The 1994 NY law CSA declares itself to be: ...a Credit Support Document under this Agreement while the 1995 English law CSA that followed hard on its heels reports that the credit support arrangements it documents: ...constitute a Transaction (for which this Annex constitutes the Confirmation). Isn’t that odd? In the ISDA universe, “Transactions” and “Credit Support Documents” are mutually exclusive things: one is an integral exchance done under the ISDA Master Agreement, the other an independent covenant that stands apart from the Aïessdiyé. Can the ’Squad, in their Wording, have meant them to be different?[1] Well, roll forward a brace of decades and see what has changed. It is the post-apocalyptic year of our lord 2016. The kind warm glow of ISDA watches over the planet’s “safe, effcient markets”. The CSA form has been updated for the new regulatory world — but the, hark! The same dissonance! The 2016 English law VM CSA, too, is a “Transaction” while its American brother the 2016 ISDA VM NY CSA is still a “Credit Support Document”! This cannot be — and not is it — an accident. Now, English lawyers like to collateralise by title transfer, and Americans by pledge. The reasons are deep and somewhat interesting — there are some essays about it in the premium content — but in any weather this leads to some profound conceptual differences between the forms of CSA, even if the practical differences are minimal. Title transfer CSAs are Transactions Since collateral passes under title transfer CSAs by title transfer, it is not a security arrangement as such: rather, the parties agree to transfer collateral to each other outright, with no expectations beyond the recipient’s conditional obligation to return something economically equivalent when trading circumstances require it. This return obligation is a debt claim against the recipient for payment of an equivalent asset and not any kind of bailment, custody arrangement or ownership right in the asset originally posted. Indeed, it resembles — is characterised as — an odd, highly personalised, self-referencing derivative Transaction. Security interest CSAs are Credit Support Documents Because they are traditional security arrangements, the security interest CSAs are characterised as “Credit Support Documents” and not “Transactions” under the ISDA Master Agreement. So a title transfer CSA works by eliminating the out-of-the-money’s indebtedness by creating an equal offsetting indebtedness which may, if push really comes to shove, be netted down to mostly nothing. A security interest CSA, by contrast, grants accepts some collateral and takes a traditional security interest over it as a surety for the indebtedness comprising that ISDA Exposure. That surety is a different covenant. It does not affect the quantum of the obligations under the ISDA: it comes into play only once they have not been honoured. These are theoretical, and not practical differences. In practical fact, the arrangements are identical. Still, this is magical, bamboozling stuff — deep ISDA lore — even though, at least where rehypothecation is allowed — and it almost always is — it makes no real difference, to the parties whether the collateral is pledged or title-transferred, because from the moment it is reused, the pledgor has only a “credit claim” against the secured party for its return. Credit support generally Credit support is designed to mitigate the frightful credit risks the parties present to each other by obliging them regularly to “cash up” their net Exposure. It should go without saying, but let’s say it: at any time, on a net basis, only one party can have an Exposure to the other. What with Independent Amounts — more of a vogue back in the 1990s in the ancient CSAs, more frowned on in the regulatory VM world of the mid 21st century — you could have both parties holding the other’s collateral, but variation margin, reflecting the actual mark-to-market value of actual transactions, could only be pointing in one direction at a time. “Credit support” transferred under a CSA is designed to offset, as closely as possible, the value of that overall “Exposure”: what the “out-of-the-money” party would owe the in-the-money party were all Transactions terminated and the ISDA closed out on any given day. The differences betwixt, and the impact of, regulatory margin Thanks to the global financial crisis and the subsequent move towards regulatory margin there are now, as I mentioned, six theoretically “live” versions of the CSA. They are as follows: The 1994 and 1995 versions may still kick around in name, but will have been heavily modified to comply with Reg Margin requirements. The main ones are the 2018 Regulatory VM CSAs — these tend now to be cash-only, zero-threshold, single-currency affairs. The Regulatory IM CSAs are a fact of life, if your portfolio is big enough to be in scope, but these are generally less operationally troublesome, though structurally complex. Most of the JC coverage will focus on the variation margin CSAs, therefore. Prime brokerage There is one corner of the market where CSA arrangements still differ a bit, and that is the Prime Brokerage world, where a customer will have a margin loan arrangement, stock lending, custody and cash accounts, and the broker will “net margin” the customer across its whole portfolio. There will still be VM CSAs, but they do quite a lot less lifting. There is a whole different part of this wiki devoted to that business. See prime brokerage. We will carry on with a deeper look at the theory and the practical differences below. Thanks for reading! This post is public so feel free to share it.

    30 min

  5. 09/13/2025

    Withholding tax and gross ups

    We’re no strangers to levyYou know withholding rules and so do I:Some tax commitment’s what I’m thinking ofYou wouldn’t get this from any other guy.I just wanna say I’m imputatingGotta make you understand: Never gonna gross you upNever gonna write you downNever gonna reach around and withhold youNever gonna make you cryNever gonn’ indemnifyWhat they can’t recharacterise can’t hurt you. We’ve known each other for so longI sealed your deed but you’re too reserved to stamp itInside we both know what’s been going onWe goin’ away, yes we’re gonna glamp itAnd if you ask me, I’m deferringMy cashflows to the next financial year: Never gonna gross you upNever gonna write you downNever gonna reach around and deduct youNever gonna make you cryNever gonn’ indemnifyWhat they recharacterise will hurt you. —Rick Astley’s IFA And to this end they built themselves a stupendous super-computer which was so amazingly intelligent that even before its databanks had been connected up it had started from “I think, therefore I am” and got as far as deducing the existence of rice pudding and income tax before anyone managed to turn it off. —Douglas Adams, The Hitch-Hiker’s Guide to the Galaxy We all know we are liable to tax on our income: this is in the “rice-pudding” category of “things that are deducible from first principles”. Now, broadly speaking, the taxman has three ways of extracting his slice of the action from the torrent of money sloshing around the financial system: he can take tax away, he can add tax on, or he can ask you to account for it later. Taxes he takes away, we call “withholding taxes”. Taxes he adds on, we call “consumption taxes” Generally, withholding and consumption taxes we call “indirect taxes” because a tax burden that ultimately falls on a person such as an employee, investor or purchaser is collected via an intermediary such as an employer, bank or retailer. The alternative is direct tax, which you pay yourself. Generally, you do this at the of the year by means of a tax return. Withholding taxes Withholding taxes are deducted from payments owed by intermediaries to the taxpayer. Here the intermediary remits the tax directly to the tax department on the taxpayer’s behalf. The best example of a tax withholding is P.A.Y.E. income tax. Withholding is often also applied on income payments under financial instruments — dividends, interest payments, but beyond that is pretty rare, for reasons I will come on to. Consumption taxes Consumption taxes are added on to the price of goods and services a taxpayer buys, so the seller acts as an intermediary, collecting the tax and remitting it to the tax department on the taxpayer’s behalf. The most common examples of consumption taxes are sales taxes, goods and services taxes and value added taxes — these are really just different names for the same thing. (For spods: the technical difference between VAT/GST and sales tax is that the former are payable at all points in the payment chain, whereas the latter are only payable on the final retail sale, though intermediaries paying VAT/GST can reclaim VAT on inputs, so the net effect is the same.) Direct taxes Or, as a last resort, the taxman can ask a taxpayer to give a full account, at the end of the year, for all her financial affairs by means of an annual tax return. Here the taxpayer must tot up all her earnings, incomings, outgoings, and credits she has received for taxes already withheld or surcharged, any taxable events, depreciations, imputation credits, concessions, benefits, exemptions and reliefs — and then apply the labyrinthine tax rules to it. For most of us indentured wage servants, P.A.Y.E. takes most of that pain away. For those outside the cosy embrace of formal employment, it is quite the process to work out, what ultimately must be rendered unto Caesar. This is a bane — it is a proper ball-ache — but yet a boon, because beyond P.A.Y.E. your tax liability falls on your net profit at the end of the year, so you can deduct your operating expenses from your income. You only pay tax on the difference, whereas a wage-earner pays tax on her gross income and cannot deduct her costs of providing her labour (her suits, bus ticket and so on). Note this difference: it is important when we get to the question of gross-up. Why tax departments like indirect taxes Tax departments like indirect taxes. They get paid sooner and more reliably, and if there is an overpayment, it is someone else’s problem to figure it out, prove it and ask for the money back. And putting the obligation on a payer at the point of payment means it is more likely taxes get paid. Equally, it is easier for a working stiff to not have to worry about receiving extra money, sitting on it, not “losing” it and then remembering to pay it when due at the end of the year. Having the whole ugly business handled automatically is, for most of us, a blessing. Likewise, hoping tourists pay taxes they owe on goods they bought and took home, or foreign investors pony up taxes owed on local interest and dividends is a bit wishful: it is better to take it first and let the taxpayers ask any questions they may have later. The tax department isn’t going anywhere: tourists you may never see again. The problem with indirect taxes This is all very well in these limited case where the final tax amount due is a determinable percentage of a given payment, as it is for wages, investment income, and certain types of retail sales. But most tax-relevant payments flying around the financial system aren’t like that. Payments made for goods and services between businesses don’t very well reflect those businesses’ final tax obligations. In fact, they bear no relation to them at all. A service sold today for £100 might cost the provider £95 to render. The provider should not have to pay tax, therefore, on that whole £100, but only on its net profit — in this case, £5. If withholding were imposed, the payer would be paying a £20 withholding in respect of a likely tax of just £1— being 20% of the actually realised £5 profit. But even that per-item net profit amount is variable. It is not determinable at the time the payment is made. The profit on a given transaction, at the point of payment for the service is a mystery. It will change from day to day as market conditions, supply, demand, and input costs fluctuate. Sometimes the provider will make a big profit. Sometimes it will the service at a loss. But in any case it won’t immediately know what its net profit on a given item is — and of course net profit is not itemised and determined per unit sold in any case. So business-to-business payments are hardly a suitable topic for indirect taxes which, by nature, are fixed, and meant to be a close-to-final estimate of the total tax payable on a given transaction. Hence: withholding taxes are generally not imposed on sales, and intermediaries are exempted from consumption taxes. Why salaries and investment income are different Salaries and investment income are the two unusual cases where indirect taxation, levied at the point of payment, is practicable. Since, generally, an employee can’t set her income off against her expenses — the tax is effectively levied on her gross income, not her “net profit” from her employment — she can’t write off her power-suits, penthouse suite, Maserati lease, luxury yachts and all-expenses paid week-long “conferences” in the Swiss Alps against her taxable income, as the self-employed gladly do. This is why, for the average working stiff, P.A.Y.E. is an effective and unobjectionable way of paying tax. There is little benefit to being paid money you are just going to have to pay back to the taxman at the end of the year. Investment income, on the other hand, is suited to indirect taxation because it is already a “net return” on a given transaction. Take a loan: I give you a million quid; you give it back. Expense-wise, we are flat. Assuming you remain solvent, the difference on the transaction is the interest you may me. That is my net return from the transaction. I do not incur any other costs specifically relating to this loan that I would not be incurring anyway. Taxing authorities are especially fond of indirect taxes on “cross border” payments from persons in their jurisdiction to persons outside it. Tax authorities have some, er, means of persuading their own citizens to pay their taxes. These are strangely ineffective against foreigners who do not have a meaningful presence — meaning assets — somewhere the tax authorities can conveniently park their tanks. Why all this matters: finance contracts vs commercial contracts All commercial lawyers are alike. Each tax lawyer is unique in her own way. Buchstein, Anna Carriedinterestova Now the Jolly Contrarian’s sophomore ramblings about income tax are all well and good — if you have made it this far, well done and thanks for bearing with — but you may be wondering what all this has to do with negotiating contracts. It is this: tax, insofar as it presents in legal contracts, baffles most practising commercial lawyers. They don’t care about it, they don’t understand it and they are not very good at it. They find people who are good at it to be weird. For commercial lawyers tend to be very much of a piece. They all enjoy the same things, talk in the same mannered way and do the same sorts of things — dull things — at weekends. You know them when you see them, by their dreary dress, dowdy haircuts, awkward dispositions and the peculiar mannerisms commercial lawyers affect when two or three gathered together. You know to avoid them at dinner parties: they make terrible “middlers”. Tax lawyers, on the other hand can be quite exciting, but often in alarming ways. They do not have a common type the way commercial lawyers do: among them will be balloonists, bike

    45 min
  6. LIBOR rigging

    03/28/2025

    LIBOR rigging

    This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit jollycontrarian.substack.com/subscribe

    50 min
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Diving into the wellspring of that is the ISDA Master Agreement jollycontrarian.substack.com

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