Credit support default: delivering quality collateral

Most OTC derivatives are done under ISDA documentation. Included in the typical package (master, confirm, definitions, schedule) is the CSA or credit support annex. This specifies what kinds of credit support, if any, each party to the contract has to give to the other. Commonly, for instance, the CSA might say (lawyerese for) 'each of us will post collateral monthly to the other if the net value of the exposure is more than $10M. Acceptable collateral is cash or G4 government bonds, and the party has three days to post the collateral after it has been requested.'

Failure to adhere to the terms of a CSA is typically a default event for the contract, resulting in the whole amount becoming due and payable.

The FT has an interesting story here in regard of one of the smaller financial guarantee insurers, ACA. Apparently ACA has written protection on the senior tranches of CDOs in the form of credit default swaps where the CSAs specify collateral in the event that the tranches are downgraded:

Such provisions require ACA to post cash equivalent to the mark-to-market loss of the CDS contract pursuant to a ratings cut.

That collateral could be substantial if ACA's CDOs have much subprime in them. Again according to the FT:

AAA rated subprime CDOs currently trade from the high single digits on junior tranches to 60% of face on super senior tranches.

If ACA can't find the collateral then presumably the whole MTM of the contracts become due and payable. Given that

ACA has only USD 1.1bn in claims paying resources, according to research by Credit Suisse

At that point the holders of the wrapped tranches will really have a problem.