{"id":47060,"date":"2016-06-13T17:14:16","date_gmt":"2016-06-13T21:14:16","guid":{"rendered":"https:\/\/www.bloomberg.com\/professional\/insights\/risk\/managing-counterparty-risk-collateral\/"},"modified":"2024-04-05T16:41:57","modified_gmt":"2024-04-05T20:41:57","slug":"managing-counterparty-risk-collateral","status":"publish","type":[3762],"link":"https:\/\/www.bloomberg.com\/professional\/insights\/risk\/managing-counterparty-risk-collateral\/","title":{"rendered":"Managing counterparty risk with collateral"},"content":{"rendered":"<div  class=\"bbg-row-container\">\n    <style>section[data-anchor=row-6a0794314c1a7]::before {\n\t\t\t\tbackground-color: #eeeeee;\n\t\t\t}<\/style>\n    <section class=\"bbg-row bg--custom-color  bg--eeeeee text--black bbg-row--full-bg-bleed\" data-anchor='row-6a0794314c1a7'>\n        \n        \n        <div\n            class=\"bbg-row--content\"\n                    >\n            \n            <p><div\n    class=\"bbg-column bbg-column--width-2\"\n    style=\"\"\n    >\n    \n<\/div><div\n    class=\"bbg-column bbg-column--width-8 bbg-column--valign-bottom\"\n    style=\"\"\n    >\n    <p>    <ul class=\"bbg-categories_list\">\n                    <li>\n                <a href=\"https:\/\/www.bloomberg.com\/professional\/insights\/category\/risk\/\" rel=\"category tag\">\n                    Risk\n                <\/a>\n            <\/li>\n            <\/ul>\n<div\n    class=\"bbg-spacer\"\n        style=\"height: 24px !important\"\n    >\n<\/div>    <h1 class=\"bbg-metadata bbg-metadata--title\">Managing counterparty risk with collateral<\/h1>\n<\/p>\n\n<\/div>\n\n\n                    <\/div>\n    <\/section>\n<\/div>\n\n<div  class=\"bbg-row-container\">\n    <section class=\"bbg-row  text--black row-padding--top-compact row-padding--bottom-none bbg-row--full-bg-bleed\" data-anchor='row-6a079431520a8'>\n        \n        \n        <div\n            class=\"bbg-row--content\"\n                    >\n            \n            <p><div\n    class=\"bbg-column bbg-column--width-2\"\n    style=\"\"\n    >\n    \n<\/div><div\n    class=\"bbg-column bbg-column--width-8\"\n    style=\"\"\n    >\n    <p><div\n    class=\"bbg-spacer\"\n        style=\"height: 40px !important\"\n    >\n<\/div>    <p class=\"bbg-metadata bbg-metadata--date\">June 13, 2016<\/p>\n<\/p>\n\n<\/div>\n\n\n                    <\/div>\n    <\/section>\n<\/div>\n\n<div  class=\"bbg-row-container\">\n    <section class=\"bbg-row  text--black row-padding--top-none bbg-row--full-bg-bleed\" data-anchor='row-6a07943153bb6'>\n        \n        \n        <div\n            class=\"bbg-row--content\"\n                    >\n            \n            <p><div\n    class=\"bbg-column bbg-column--width-2\"\n    style=\"\"\n    >\n    \n<\/div><div\n    class=\"bbg-column bbg-column--width-8\"\n    style=\"\"\n    >\n    <p><div\n\tclass=\"bb-wysiwyg\"\n\t\t>\n\t<p>Before the 2007 financial crisis, collateral management was just a simple, cash-denoted process to insure firms against the risk of default by their counterparties.\u00a0 But, regulatory aftershocks in the form of European Market Infrastructure Regulation (EMIR), Dodd-Frank\u2019s Title VII and the Alternative Investment Fund Managers Directive (AIMFD) disrupted traditional cash models for collateralization.\u00a0 New laws require that banks fund deals over longer terms, while holding more capital against unsecured trades.<\/p>\n<p>Buy-side firms, on the other hand, have to exchange their high-yielding instruments for cash and government bonds to meet regulator demands for higher quality and more diverse collateral.\u00a0 In the OTC derivatives market, collateral management has become more than a risk-management tool \u2013 it\u2019s a strategic process to drive profitability.<\/p>\n<p>In a recent Bloomberg webinar, corporate treasury market specialists, Leonid Prujanski and Simone Mecca, discussed how collateralization helps mitigate counterparty risk in OTC derivative transactions.<\/p>\n\n<\/div>\n<div\n\tclass=\"bb-wysiwyg\"\n\t\t>\n\t<p><strong>OTC derivative collateral: A history<br \/>\n<\/strong><\/p>\n<p>The collateralization of OTC derivative contracts optimizes efficiencies between counterparties by reducing credit risk, improving pricing and expanding market access.\u00a0 The practice of collateral management has existed since the 1980s when Bankers Trust and Salomon Brothers began taking collateral against credit exposure.\u00a0 Derivative collateralization became more prevalent in the 90s, which led to the development of standardized rules by the International Swaps and Derivatives Association in 1994.<\/p>\n<p>Despite the proven benefits of collateralization, it is still not an established practice among corporate treasurers today. Many treasury officers do not even fully understand the extent to which collateralization impacts their operations on a daily basis.\u00a0 Take for example the counterparty value adjustment and direct value adjustment calculations, which became standard during the global financial crisis.\u00a0 CVA and DVA valuations calculate the non-performance-related risks of derivative assets, or the liabilities of the contract\u2019s counterparty.\u00a0 Additionally, many banks have begun applying OTC derivative pricing conventions like dual curve stripping and overnight interest swap discounting, once exclusive to interbank contracts, to their trades with corporate counterparties.<\/p>\n<p><strong>Liquidity risk vs. credit risk<br \/>\n<\/strong><\/p>\n<p>A poll conducted during the webinar found that the majority of respondents avoided the practice of collateralizing their OTC derivatives due to liquidity concerns.\u00a0 Liquidity presents a roadblock for many treasurers because they project scenarios where adverse market movements inflict punitive capital outflows. Other drawbacks include the complexity of collateral contract architecture and the overconcentration of risk in one or a few counterparties.<\/p>\n<p>Nevertheless, the benefits of collateralization outweigh the disadvantages.\u00a0 Strategic collateral management mitigates current and projected exposures to losses in the event of counterparty default, ensures better pricing through credit-risk reduction and enhances access to markets through additional counterparties who would otherwise decline to transact on a non-collateral basis.\u00a0 This enhanced market access helps diversify and further mitigate counterparty risks.\u00a0 And in an evolving global market, where OTC pricing norms are increasingly being defined by the surging volume of outstanding collateral and margin calls, Treasurers whom defy the status quo may suffer adverse and unprofitable contract terms.<\/p>\n<p><strong>Managing counterparty relationships<br \/>\n<\/strong><\/p>\n<p>Collateral management is a proven solution to improve OTC derivative transactions between counterparties.\u00a0 Eligible collateral includes cash, bonds, gold and other company or bank assets.\u00a0 Interest earned on collateral can be complicated by the current negative-rate regime dictating monetary policy in Asia and increasingly in Europe. The anomaly can be resolved by negotiating a floor with the bank when the rate hits zero or following ISDA\u2019s 2014 guidance, which assesses the absolute value of the negative rate.\u00a0 Additionally, the valuation agent should be clearly defined in contracts to mitigate time-intensive and resource-exhaustive legal risks.<\/p>\n<p><strong>Technology is key<br \/>\n<\/strong><\/p>\n<p>With the right technology, corporate Treasurers can address the escalating volume, regulatory complexity and frequency of collateralized transactions.\u00a0 Treasurers are searching for a way to monitor, centralize and manage all derivative-collateral exposures and related legal documentation in real-time with a reliable workflow, integrated with market-leading data.\u00a0 It\u2019s critical that this tool also be fully compliant with the most recent Dodd-Frank and EMIR regulations.<\/p>\n<p>For all Treasurers, a resource that mitigates counterparty risks and optimizes return on equity is the ideal solution.\u00a0 The sprawling, accelerating and diversifying collateral ecosystem demands a nimble solution that can adapt to challenges and empower Treasurers with a strategic asset that drives value, where spreadsheets would compound risk.<\/p>\n\n<\/div>\n\n<div\n  id=\"cta_8619673635281950980\"\n  class=\"wpb_content_element bbg-cta icon icon-arrow\">\n  <style>\n    \n    \n    \n  <\/style>\n  <div\n    class=\"bbg-cta-link link-holder\"\n    data-links-type=\"cta-links\">\n    <p class=\"bbg-cta-p left\">\n      <a\n        class=\"bbg-cta-link link\"\n        href=\"http:\/\/www.bloomberglp.com\/collmgmt\"\n        target=\"\"\n        rel=\"\"\n        data-section-name=\"View the webinar\"\n        >\n                      View the webinar\n                <\/a>\n    <\/p>\n  <\/div>\n<\/div>\n\n<\/div>\n\n\n                    <\/div>\n    <\/section>\n<\/div>\n\n<div  class=\"bbg-row-container\">\n    <style>section[data-anchor=row-6a07943156e1f]::before 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