The recent financial markets crises have heightened and increased focus on collateralization.
Collateralization is a process where a borrower pledges an asset as recourse or cover or a security to the lender for facilities or limits or credits extended by the lender and these collaterals will come in handy in the event the borrower defaults on the loan. Collateralization of assets gives lenders a sufficient level of reassurance against default risk, which allows loans to be issued to individuals / companies and corporate with less than optimal credit history and / or debt rating.
The increasing risk awareness these days are leading to demand for operational efficiency and push for standardization, automation and cost consciousness. The changes in regulatory landscape coupled with strong hand and voice of regulators are forcing the market participant to have a relook at extant collateralization models and processes – bilateral and triparty.
The following table captures the finer points of bilateral and triparty collateral management.
|
Process |
Bilateral | Triparty |
| Selection of collateral | Manual or Automated | Automatic Selection |
| Eligibility Criteria | Simple | Sophisticated |
| Mark to Market | Daily, Weekly or even Monthly | Daily and automated; can be made even real time |
| Margin calls | Once a day, weekly or even monthly | Fully automated |
| Settlement | Required follow up | Automated |
| Substitution | Once a day and Get before you give | Unlimited and Delivery Versus Payment |
| Optimization | Limited | Automated across all asset types |
| Administration | Manual | Automated |
We all know collateralization per se does not remove the counterparty credit risk. It converts the counterparty credit risk into operational risk, settlement risk, market risk and liquidity risk.
The various components of collateralization process are – selection of collateral, valuation of collateral, margin calls, settlement, substitution, optimization and administration.
In the case of bilateral collateral management, the process is totally in house with the various processes integrated into back office functions. Also another important aspect of bilateral process is direct contact with the counterparties.
In the case of triparty collateral management, the process is outsourced to a neutral agent to perform with a view to manage Reduce Operational, Settlement, Market and Liquidity risks.
The agents who offer tri party collateral management as a service provide the following offerings.
- Optimization
- Re-hypothecation
- Substitution
- Concentration
- Simulation
- Valuation
- Exposure Computation
- Margin Calculation
- Reconciliation
- Corporate actions
- Inventory management
- Cash management
Some of their special offerings could be grouped under as follows
– Trade Life Cycle
- Trade matching
- Interest computation
- Trade settlement
– Inventory / Cash
- Trade info
- Trade maturity
- Trade reversal
- Transfer instruction
- Recall
- Corporate Actions
– Default process
- Margin calculation
- Margin life cycle
- Credit lines
- Liquidation
Collateral management as a subject is highly complex and risky. One should be very thorough with the basics to manage well.