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Collateral management
Collateral has been used for hundreds of years to provide security against the possibility of payment default by the opposing party in a trade. Collateral management began in the 1980s, with Bankers Trust and Salomon Brothers taking collateral against credit exposure. There were no legal standards, and most calculations were performed manually on spreadsheets. Collateralisation of derivatives exposures became widespread in the early 1990s. Standardisation began in 1994 via the first ISDA documentation.
In the modern banking industry collateral is mostly used in over the counter (OTC) trades. However, collateral management has evolved rapidly in the last 15–20 years with increasing use of new technologies, competitive pressures in the institutional finance industry, and heightened counterparty risk from the wide use of derivatives, securitization of asset pools, and leverage. As a result, collateral management is now a very complex process with interrelated functions involving multiple parties. Since 2014, large pensions and sovereign wealth funds, which typically hold high levels of high-quality securities, have been looking into opportunities such as collateral transformation to earn fees.
Borrowing funds often requires the designation of collateral on the part of the recipient of the loan.
Collateral is legally watertight, valuable liquid property that is pledged by the recipient as security on the value of the loan.
The main reason of taking collateral is credit risk reduction, especially during the time of the debt defaults, the currency crisis and the failure of major hedge funds. But there are many other motivations why parties take collateral from each other:
These motivations are interlinked, but the overwhelming driver for use of collateral is the desire to protect against credit risk. Many banks do not trade with counterparties without collateral agreements. This is typically the case with hedge funds.
There is a wide range of possible collaterals used to collateralise credit exposure with various degrees of risks. The following types of collaterals are used by parties involved:
The most predominant form of collateral is cash and government securities. According to ISDA, cash represents around 82% of collateral received and 83% of collateral delivered in 2009, which is broadly consistent with last year’s results. Government securities constitute fewer than 10% of collateral received and 14% of collateral delivered this year, again consistent with end-2008. The other types of collateral are used less frequently.
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Collateral management
Collateral has been used for hundreds of years to provide security against the possibility of payment default by the opposing party in a trade. Collateral management began in the 1980s, with Bankers Trust and Salomon Brothers taking collateral against credit exposure. There were no legal standards, and most calculations were performed manually on spreadsheets. Collateralisation of derivatives exposures became widespread in the early 1990s. Standardisation began in 1994 via the first ISDA documentation.
In the modern banking industry collateral is mostly used in over the counter (OTC) trades. However, collateral management has evolved rapidly in the last 15–20 years with increasing use of new technologies, competitive pressures in the institutional finance industry, and heightened counterparty risk from the wide use of derivatives, securitization of asset pools, and leverage. As a result, collateral management is now a very complex process with interrelated functions involving multiple parties. Since 2014, large pensions and sovereign wealth funds, which typically hold high levels of high-quality securities, have been looking into opportunities such as collateral transformation to earn fees.
Borrowing funds often requires the designation of collateral on the part of the recipient of the loan.
Collateral is legally watertight, valuable liquid property that is pledged by the recipient as security on the value of the loan.
The main reason of taking collateral is credit risk reduction, especially during the time of the debt defaults, the currency crisis and the failure of major hedge funds. But there are many other motivations why parties take collateral from each other:
These motivations are interlinked, but the overwhelming driver for use of collateral is the desire to protect against credit risk. Many banks do not trade with counterparties without collateral agreements. This is typically the case with hedge funds.
There is a wide range of possible collaterals used to collateralise credit exposure with various degrees of risks. The following types of collaterals are used by parties involved:
The most predominant form of collateral is cash and government securities. According to ISDA, cash represents around 82% of collateral received and 83% of collateral delivered in 2009, which is broadly consistent with last year’s results. Government securities constitute fewer than 10% of collateral received and 14% of collateral delivered this year, again consistent with end-2008. The other types of collateral are used less frequently.