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Treasury Consulting > Collateral management

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Client:   European Mutual

Collateral Management

The firm identified that counterparty credit exposures on OTC derivatives was adversely affecting the ability to trade. It was agreed that collateral management was a solution. But the firm did not want to invest in a collateral management system and have all the operational support issues.

It was agreed that the existing credit and valuation systems could be used with spreadsheets in order to manage the processes prior to buying a system or outsourcing.

The deliverable included a documented process that could be run internally from the existing systems. This collected the valuations, recorded the collateral position and linked the collateral to current credit exposures.

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Counterparty credit exposure (CCE) is a big issue it's why you have credit limits. When you lend money the risk is clear, will you get repaid? But with over the counter derivatives (like swaps) credit exposures are harder to see but nevertheless they are real. Derivatives with positive mark-to-market values generate credit risk. Why? Because default by the counterparty puts your profit at risk. One solution is collateral management. This involves a regular trade portfolio valuation and a net exchange of margin or collateral between the two parties involved. Collateral management is a process; it mitigates your credit risk but at the same time increases your operational risks. It's too easy to focus on the credit aspect of collateral without identifying what else could go wrong. Let's have a look at ten of the main concerns. It's not an exhaustive list but it may help you identify where improvements can be made.