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Collateral ManagementCollateral Management aa practitioners perspectivepractitioners perspectiveMichael PayneMichael PayneNordic Capital Markets Forum January 2006Nordic Capital Markets Forum January 2006
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AgendaAgenda
4Drivers behind Collateral
4 Operational Aspects4 Market Overview
The information in this document has been obtained from and is based uponsources believed to be reliable but it may be incomplete or condensed and
its accuracy cannot be guaranteed.
2006 Citigroup Global Markets Limited. Citigroup and the umbrella deviceare trade marks and service marks of Citigroup Inc. or its affiliates andare used and registered throughout the world.
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What is Collateral ManagementWhat is Collateral Management
! Definition - Collateralisation is a credit enhancement techniqueand is a means of mitigating credit risk associated with privatelynegotiated derivatives transactions.
! Can be used for either individual deals or a large portfolio ofdeals.
Source ISDA guidelines for collateral practitioners
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What is Credit RiskWhat is Credit Risk
4 Definition - The risk that a counterparty will default under itsobligations in whole or part.
Source AFMA Handbook August 2002
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Collateral CalculationZero ThresholdCollateral CalculationZero Threshold
PARTY A PARTY B
Currency Swap - $40m
IR Swap - $10m
IR Collar - $5m
FX Forward - ($68m)
Net Exposure - $13m
Collateral already posted - $0m
Delivery requirement - $13m
Party B transfers or pledges$13m minimum cash or securities as collateral toParty A until exposure returns to an acceptable
level for Party A
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Why use CollateralWhy use Collateral
4 Reduce Credit risk4 Capital savings4 Increased competitiveness4 Improved market liquidity4 Access to complex or higher risk trades4 Required by counterparty
4 Source ISDA Margin Survey 2002
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Collateral
Risk transference?Risk transference?
CreditRisk
OPERATING RISKSAgreement structure riskMonitoring control riskConcentration riskMarket risk on collateral valueCorrelation risk
Third party and settlement risk
LEGAL RISKSProcedural riskPerfection riskRecharacterization riskPriority riskEnforcement riskLocal risk factors
Murphy risk
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Effects of CollateralisingEffects of Collateralising
FX IRS Com CF Etc.
Non-collateralised client - trading mentality
FX IRS Com CF Etc.
Collateralised client - relationship mentality
Collateral Management Group (generalists)
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The real effect of collateral.
Party A - Exposure - February/March
1 5 , 0 0 0
, 0 0 0
2 0 , 0 0 0 , 0 0
0 2 5 ,
0 0 0 , 0 0
0 3 0 ,
0 0 0 , 0 0
0 3 5 ,
0 0 0 , 0 0 0
4 0 , 0 0 0
, 0 0 0
0 1 - F e b 0 3 -
F e b 0 5 -
F e b 0 7 -
F e b 0 9 -
F e b 1 1 -
F e b 1 3 -
F e b 1 5 -
F e b 1 7 -
F e b 1 9 -
F e b 2 1 -
F e b 2 3 -
F e b 2 5 -
F e b 2 7 -
F e b 0 1 -
M a r
0 3 - M a
r 0 5 -
M a r
0 7 - M a
r 0 9 -
M a r
1 1 - M a
r 1 3 -
M a r
1 5 - M a
r 1 7 -
M a r
1 9 - M a
r 2 1 -
M a r
2 3 - M a
r 2 5 -
M a r
Valuation Dates
O u t o f
t h e
M o n e y
Exposure Threshold Post Collat Exp Postings
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Operational IssuesOperational Issues
4 Relationship between Collateral operations, Credit, Front Office& Legal Department4 Involvement in agreement negotiations4 Timing of margin calls and collateral deliveries4 System Development Can your system capture all the
requirements of the agreement4 Withholding Tax?
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Agreement IssuesAgreement Issues
4 Products covered generally means all trades covered byISDA Master agreement (Derivatives + FX)4 Can exclude entire product type e.g Credit Derivatives4 Agreement must reflect operational capabilities4 Should include all existing + new trades4 Compare trades & mark to markets before agreement is
signed
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Daily Margin Call ProcedureDaily Margin Call Procedure
4All trades and collateral are marked to market daily
4 Collateral can be called/recalled daily4 When a call is received pay the undisputed amount , work out
the rest4 Collateral moves next normal settlement day
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Disputes with a counterpartyWhat do you do if a counterparty disagreesDisputes with a counterpartyWhat do you do if a counterparty disagrees
4 Check the collateral values are correct4 Check major fx spot rates4 Check branches/products covered by CSA are correct4 Check Thresholds, MTA, and rounding amounts correct
4 Perform trade tick back with counterparty4 Get External Quotes as part of formal dispute resolution
procedure
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Eligible CollateralEligible Collateral
4Must be approved by credit department
4 Must be included in the agreement4 Important to enforce with counterparty4 Easy to Settle4 AAA rated4 Haircuts must be taken into account
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ISDA Margin SurveysISDA Margin SurveysGlobal collateral
2001 USD250b 2002 USD437b 2003 USD719b 2004 USD1,017b 2005 USD1,209b 2006 USD1,329b
Margin Agreements 2000 - 11,000 2001 - 16,000 2002 - 28,000 2003 - 37,500 2004 55,000
2005 71,000 2006 110,000
Collateral
Cash 72.9% Govt Securities 11.8% Other 15.3%
Type of Agreement NY law (pledge) 53% Eng. law (transfer) 22% Eng. Law (deed) - 0.2% 2001 Margin Prov. - 0.1%
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Market InitiativesMarket Initiatives
4Electronic data interchange 2003
4 Collateral Asset Definitions 20034 Enterprise wide Collateral Management 20034 Glossary of terms for the Chinese market 20054 Review and republishing of Collateral Guidelines 20054 Collateral Market Practices (current)4 Portfolio Reconciliation (current)
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Australian market - case studyAustralian market - case study
More cross-border than domestic Purpose is facilitation rather than mitigation Relatively long start-up periods
Expertise, systems, global revals, CSA negotiations Toe-dipping (high thresholds, inactive CSAs) Collateral generally non-AUD (IWT concerns) Emerging Asia-Pacific time-zone
Tokyo, Hong Kong, Singapore, Sydney Corporate activity is only among top tier & some funds Understanding was low on both sides
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Further InformationFurther Information
2005 ISDA Collateral GuidelinesISDA Margin SurveysMastering Collateral Management & Documentation-A Practical Guide forNegotiators, P Harding & C Johnson, Prentice Hall 2003
ISDA Collateral Committee
www.isda.org
http://www.isda.org/http://www.isda.org/8/6/2019 Presentation Michael Payne
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Questions!Questions!
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