Negotiating Collateral Fees for Existing OTC Derivatives
Summary
The document considers whether a dealer can charge a client a fee when the parties add cash collateralization to an existing, uncleared derivatives relationship. Its setup assumes a master agreement and a single-currency collateral agreement with zero thresholds and minimum transfer amounts, one netting set, no bilateral initial margin, and a positive portfolio value to the dealer at negotiation. The question is whether reduced credit valuation adjustment (CVA) and increased funding valuation adjustment (FVA) justify a charge.
The response focuses on the direction of collateral flows: the client posts collateral to the dealer, which removes much of the dealer’s unsecured exposure and its associated CVA. It says the dealer should consider what it must pay, rather than assuming it can charge the client; a share of the CVA benefit might be negotiated, but the client would need a reason to accept that arrangement. The answer is qualitative and brief. It does not quantify funding costs or establish a general fee formula, so actual bargaining outcomes depend on the trade economics and counterparties’ alternatives.
Key ideas
- Collateral posted by the client reduces the dealer’s unsecured exposure and CVA.
- The direction of collateral flows shapes which party may have negotiating leverage.
- A dealer’s ability to charge a fee cannot be inferred from increased FVA alone.
- Sharing part of the CVA benefit may be negotiated, but the client needs an incentive to agree.
- The discussion is qualitative and gives no quantitative fee valuation method.
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Full text
# Understanding the cost involved in collateralization of existing OTC business # Understanding the cost involved in collateralization of existing OTC business I am looking for a qualitative assessment regarding the (negotiable) 'cost' incurred when two counterparties agree on collateralizing existing derivatives business. I think the core of my question is: What is the admissible / theoretically justifiable 'negotiation space' when it comes to (trying to) charging fees from a derivatives desk's client? I am happy to try to make my question more precise where necessary. Assume that a swap dealer bank $D$ and a (small) client bank $C$ have a Master Agreement in place and have recently extended it with a standard CSA (single currency cash collateral, zero thresholds / no MTA, single netting set across all derivatives). There is no bilateral initial margin requirement. The two are now 'negotiating' the fee of collateralizing their existing bilateral (i.e. non-cleared) swap derivatives business. We may assume that - at time of negotiation - the netting set has a positive PV to the dealer bank $D$. I am looking for a (qualitative) assessment of the valuation adjustments the dealer bank $D$ will consider and try to exert from the client bank $C$ in form of a fee. My thoughts so far: - CVA decreases. It is not reasonable for $D$ to charge for a CVA component as CVA is being reduced. The same reasoning should hold from $C$'s perspective. In total, I'd argue that $D$ may (reasonably) only try to charge a fee for their increase in FVA. Is that reasoning comprehensible, or is there a flaw? Happy to get your thoughts on this. If the problem is undecidable as is, I am happy to provide additional assumptions. Thanks in advance. ## Answer by dm63 (score 3, accepted) https://quant.stackexchange.com/a/74033 I think that the negotiating space is to ask how much will D have to pay (not receive). The dominant economic effect is that C will have to send collateral to D, which is really the same as saying the CVA is being removed. In those situations usually a percentage of the CVA may sometimes be paid but why would C do this unless they were getting paid something. If D can do the trade for zero , it’s a home run.
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