Collateral Management Guide PART 4: The Collateral Landscape
Author: Financial-edu.com
The collateral management landscape has changed rapidly in recent years. While collateralization has always been important in OTC transactions, the recent global credit crisis has put a spotlight on the need to fully understand and protect against credit risk in highly leveraged OTC derivative transactions.
Growth of Collateralized Transactions
The following growth figures were obtained from ISDA. Post-2007 numbers may not be as accurate, since many of the major reporting prime brokers have either gone under, cut their staff significantly, or are in the midst of legal actions to recover or defend against giving back collateral. Since OTC transactions need not be reported to regulatory authorities in most jurisdictions it is difficult to obtain accurate figures. However, these numbers show 5x growth in collateral value since 2001.
Year Collateral Value (USD billions) 2001 $250 2002 $437 2003 $719 2004 $1017 2005 $1209 2006 $1329
- U.S. and Canada have highly developed collateral markets focused on cash and Treasury Bonds.
- Europe has highly efficient fixed income collaterization, fragmented equity markets, and historically fragmented settlement and clearing infrastructures (this is improving rapidly). Europe still has fragmented tax systems, legal systems and variations in collateral treatment during bankruptcy.
- The Middle East has a rapidly developing collateral market in a form which is acceptable under Sharia or Islamic Law. Lending is largely illegal in Muslim countries, which includes lending securities. Under Islamic banking law, most deals must be fully secured with collateral to ensure that no credit is extended between counterparties.
- Latin America has a developing collateral market, but is hindered by inefficient legal systems, under-developed custody and IT systems, and access to quality collateral. Commodities and government bonds (including U.S. Treasuries) are the preferred form of collateral.
- Asia is a mix of rapid development in China, Malaysia, Indonesia, Korea, etc. and a mature and sophisticated market in Japan. In general, credit (and hence the need for collateral) is used more conservatively, and large banking relationships backed by government intervention tend to limit defaults. China's adoption of common collateral definitions in 2005 was a major milestone to development of efficient OTC and derivatives markets in Asia.
Key Technical and Legal Developments in Collateral Operations
- 2003 Electronic Data Interchange (EDI) standards developed to automate collateral transactions and communications. - 2003 ISDA Collateral Asset Definitions: standardized the definitions of eligible collateral. - 2003 Enterprise Wide Collateral Management: Netting on a portfolio, customer, and enterprise-wide basis is embraced to increase efficiency, cut costs, and include a wider range of risks. - 2005 Chinese Market Collateral Glossary: The Chinese join with other trading powers in defining key terms to use in collateral and credit agreements. - 2005 ISDA Collateral Guidelines: ISDA embraces industry advances and lays out standard bi-lateral and tri-lateral operational processes. - Collateral Market Practices published - Portfolio Reconciliation published to provide guidelines on managing complex collateral portfolios. - July 31, 2008 Major Dealers in the Operation Management Group letter to the U.S. Federal Reserve: by Dec 31, 2008 the major participating dealers agreed to a goal of weekly interdealer reconciliation of collaterized portfolios with more than 5,000 trades, the provision of adequate resources to the collateral management function to identify and resolve differences, collect and report metrics to supervisors (thus driving increased demand for systems to capture data and report disputes and risk metrics).
