Presentation on theme: "Collateral: Transforming Counterparty Risk into Legal and Operational Risks Robert McWilliam Head of Counterparty Exposure Management."— Presentation transcript:
Collateral: Transforming Counterparty Risk into Legal and Operational Risks Robert McWilliam Head of Counterparty Exposure Management
5 Years Ago….. Collateral reduced credit losses during Asia, Russia and Hedge Fund ‘crisis’ in 1997/98 ISDA estimated $200bn collateral assets 9 ISDA Collateral opinions High thresholds linked to credit worthiness Calendar driven or mtm margin calls Weekly/monthly margin frequency Single product margining
ISDA 1999 Collateral Review Reduction in time frames associated with call cycle and substitutions Revised dispute resolution procedure Broadening of scope to include reconciliation and exchange of information Simplification of definitions and language Simplification of document architecture
While collateral reduces credit risk, it simultaneously increases other risks to which banks are exposed, such as legal, operational, liquidity and market risk. Therefore, it is imperative that banks employ robust procedures and processes to control these risks. The New Basel Capital Accord, January 2001 Basel II
FundingCorp bonds, EquityGovt Bonds Industry OpinionsBespoke Legal High Threshold Infrequent Calls Zero Threshold Daily Calls Operations DocumentationGMRA, ISDAClient Driven PortfolioPassiveActive SettlementGovt Bonds, CashCorp Bonds, Equity Low CostHigh CostRisk Legal and Operational Risks
Is the Collateral Yours to Keep? Perfection and enforcement risk for pledges Re-characterisation risk for title transfer Uncertainty under conflicts of law rules as to which law applies Vulnerability to third parties Enforceability of “top-up” deliveries
ISDA Collateral Agreements Operational Provisions Legal Provisions Definitions Elections Supplement New York Pledge English Transfer English Deed Japanese Pledge/Loan
Time Frames 3 day call cycle: Value - Notify - Settle Contrast FX Margin, Repo markets 2 day substitution: Deliver - Return Double-up credit risk overnight Market practice may differ from CSA terms Increased legal risk??
CSA Para 4 - Dispute Resolution (1) Disputing party to notify other party by close of business on the LBD following the date that the demand is received (2) transfer the undisputed amount (3) parties to consult in an attempt to resolve the dispute (4) if they fail by the Resolution Time, then: (i) Valuation Agent to seek 4 actual mid-market quotes (ii) recalculate collateral value pursuant to 11(e)(ii) Following recalculations, Valuation Agent will notify each party not later than Notification Time on LBD following Resolution Time Failure to make the required transfer results in an Event of Default under ISDA Master Section 5(a)(i) ‘Failure to Pay or Deliver’ subject to a standard 3 day cure period.
AGREEMENT DATA CUSTOMER REFERENCE DATA COUNTERPARTY DATA STATIC DATA COLLATERAL ASSET DATA TRANSACTION DATA MARKET DATA Collateral System Data Requirements
Portfolio Risks Liquidity and volatility Collateral eligibility and haircuts not sensitive to market Concentration Within portfolio and across the firm Correlation of your counterpart with: Issuer of collateral asset; “two-party pay” risk Market events
CUSTODY DATA MANAGEMENT CONFIRMATIONS PAYMENTS RISK & LEGAL FINANCIAL CONTROL TRADING DESK Margin Team Communications Centre
FundingActive re-use, cross product margining EU Collateral Directive, Hague Convention Legal Continued investment in systems and people Central Counterparties, Outsourcing Operations DocumentationISDA Margin Provisions 2001, GMRA 2000 PortfolioWider collateral acceptance SettlementConsolidation of platforms Changes in Market EnvironmentRisk Trends in Collateral Use
And the Future…. Collateral is much more widely used New entrants; insurance/pension funds, corporate, emerging markets Tighter credit terms; zero threshold, daily calls Risk based margining across wider product range Improvement in collateral risk management More highly skilled practitionersimproved business process Better technology support ISDA initiatives: Electronic Date Interchange, Asset Definitions, Guideline update, revised CSA, Law reform… New tools to manage counterparty risk: CDS, Tear-ups, Third Parties