Standardized credit support annex to benefit swaps market.

The launch by the International Swaps and Derivatives Association of a standardized credit support annex (SCSA) will accelerate the trend toward a more accurate method for pricing OTC interest-rate swaps.

The SCSA seeks to promote the adoption of overnight indexed swap (OIS) discounting for derivatives.

“Most dealers now recognize that the OIS curve is the correct discount rate for cash collateralized trades, as this is used to calculate the interest rate paid on collateral,” Rohan Douglas, CEO of Quantifi, told Markets Media.

An overnight indexed swap (OIS) is an interest rate swap where the periodic floating rate of the swap is equal to the geometric average of an overnight index (i.e., a published interest rate which is also called Overnight Rate) over every day of the payment period.

The index is typically an interest rate considered less risky than the corresponding interbank rate (LIBOR).

The SCSA supports the move to OIS discounting by grouping derivatives into separate buckets or “silos,” based on currency. Each currency silo is evaluated independently to generate a required movement of collateral in the relevant currency.

“The complexity arises when counterparty can choose from a list of eligible collaterals in different currencies, basically exercising the ‘cheapest-to-deliver’ option,” Douglas said.  “But the latest CSA standard will significantly reduce this ambiguity by assigning the trade to one of five liquid currencies, and most clearing houses are actively implementing this approach.”

In the United States, OIS rates are calculated by reference to daily federal funds rate.

Discounting methodologies that take into account OIS spreads—that is, the difference between OIS rates and LIBOR—are increasingly popular and are progressively replacing LIBOR-based methodologies.

CCPs, notably LCH.Clearnet, are moving to OIS discounting methodologies in their swap-clearing activities.

Since 2010, LCH has been using the OIS rate curves to discount its interest-rate swaps portfolio in its SwapClear IRS service.

Previously, in line with market practice, the portfolio was discounted using LIBOR.  However, an increasing proportion of trades are now priced using OIS discounting.  LCH.Clearnet decided to move to OIS to ensure the most accurate valuation of its portfolio for risk management purposes.