Independent Amount

An independent amount is a fixed or formula-based amount of collateral that one or both parties to a bilateral derivatives trade must post, over and above the variation margin that tracks the trade's day-to-day change in value. It exists to cover potential future exposure: the risk that, between the point a counterparty stops posting margin and the point its position is finally closed out, the trade's value could move sharply against the surviving party. Variation margin alone only reflects losses that have already occurred; an independent amount is held in reserve for losses that have not happened yet but plausibly could.

The term comes from the credit support documentation historically used under bilateral International Swaps and Derivatives Association (ISDA) agreements, where it functions much like initial margin does in cleared markets, though it is negotiated privately between two counterparties rather than set by a central counterparty (CCP). An independent amount can be a flat figure agreed at the start of a relationship, a percentage of notional exposure, or, under current regulatory margin rules, a figure calculated using a standardized model.

Picture a landlord who asks a new tenant for a security deposit before move-in, separate from the monthly rent the tenant pays as they go. The rent covers what is owed for the time already lived in the apartment; the deposit exists for the possibility of damage that has not happened yet but could, by the time the tenant eventually moves out. The landlord does not wait to see damage before asking for the deposit, because by the time damage is visible, the deposit needs to already be in hand.

An independent amount works the same way for a trading relationship. Variation margin is like the rent, settling up what is already owed based on how the trade has moved so far. The independent amount is the deposit, collected upfront to cover the possibility that, if the counterparty gets into trouble, the trade's value could swing further before the position can be unwound.

In its simplest form, the total collateral a counterparty must hold against a bilateral derivatives position can be expressed as:

Here $C$ is the total collateral required, $VM$ is variation margin reflecting the trade's current mark-to-market value, and $IA$ is the independent amount. For example, if a trade currently shows a mark-to-market loss of 200,000 to one party, that party owes 200,000 of variation margin. If the agreement also specifies an independent amount of 50,000, the total collateral that party must post is:

The 50,000 is held regardless of the current mark-to-market value, as a buffer against further adverse moves before a default could be resolved.

• By private negotiation, reflecting the counterparty's credit quality, historical volatility of the traded product, and the size of the position.
• As a flat percentage of the trade's notional amount, common in relationships with weaker-rated counterparties.
• Under regulatory initial margin rules for uncleared derivatives, calculated using a standardized model such as the ISDA Standard Initial Margin Model, which produces a result that functions as a regulatory-mandated independent amount.
• Through periodic review as the counterparty's credit standing or the trade's market risk changes, since an amount fixed at the start of a long-dated trade can become stale if conditions shift significantly.

Both concepts cover potential future exposure during the margin period of risk, but initial margin at a CCP is calculated using the clearing house's own standardized model and held by the CCP itself, mutualized across all members through its default waterfall. An independent amount, by contrast, is a bilateral arrangement between two specific counterparties, individually negotiated or calculated, and held by whichever party is specified in the agreement, sometimes with a third-party custodian holding it on both parties' behalf.

Since the 2008 financial crisis, regulators have required that independent-amount-style margin be exchanged on most uncleared derivatives between large financial counterparties, under rules developed by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions, and implemented through the Dodd-Frank Act in the United States and MiFID II in Europe. These rules standardized how the amount is calculated and required that it be held with an independent custodian, reducing reliance on purely bilateral negotiation.

• International Swaps and Derivatives Association (ISDA)
• Basel Committee on Banking Supervision