When trading OTC derivatives or other transactions which might have a long time scale to them, it is necessary to have in place robust legal documentation so that both counterparties are aware of how that transaction will proceed through its entire life, including what will happen in the event of bankruptcy of one counterparty and events such as the requirement to pledge collateral. One way in which this can be done for OTC derivatives is using an ISDA Master Agreement. ISDA is the International Swaps and Derivatives Association and they have pulled together an agreement which lays out standardized terms and conditions, like counterpart may wish to include in legal documentation between themselves for trading OTC derivatives. This document is agreed between two counterparties on a bilateral basis. So, for a bank that is engaging in OTC derivative transactions with many counterparties there may well be many ISDA agreements in place between this bank and those counterparties. The master agreement can be adjusted and as a result of negotiations between the two counterparties of the trade can take many months to be agreed. Some of the key terms included within an ISDA Master Agreement will be responsibilities in the event of default and requirements with regards to netting of exposures if a counterparty owes money and is owed money by someone that they are trading with, then the netting agreement will typically state that those exposures are netted off to give one net obligation if one counterparty goes bankrupt. Also, within the ISDA is a document referred to as the Credit Support Annex or the CSA and this defines the key elements of the collateral arrangements in place between those two counterparties. Some of those key elements that are defined within a credit support annex are firstly the eligible collateral what is allowed to be posted or pledged as collateral from one counterparty to another, and the currencies that collateral must take exposure would refer to how counterparties are calculating the credit risk that they face between each other, who is responsible for that calculation and what happens in the event of a dispute between counterpart as to the level of exposure on particular transactions? Threshold refers to the losses experienced on a mark-to-market value basis above which collateral must be pledged. If a CSA between two counterparties has a threshold of $1,000,000, then as one of those counterparties sees the mark-to-market exposure of those derivative contracts between themselves and the counterparty going above $1,000,000, they must pledge collateral for any amounts that the exposure goes above a million. So, if the exposure was $1.2 million of losses that were suffering on a mark-to-market basis and the threshold was $1,000,000, they would need to pledge $200,000 worth of collateral. The minimum transfer amount refers to the smallest amount which must be pledged as collateral. So, if the threshold was, again, $1,000,000 and the exposure goes up to $1,050,000, this suggests that the cash required to be paid would be $50,000. However, if the minimum transfer amount was $100,000, then this $50,000 would not be required to be paid because it is below the minimum transfer amount.

Frequency refers to how often the calculation is made as to the level of exposure between the counterparties and the need for collateral to be paid.