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Collateral Management; from back to front office activity

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Interview with Martin Defauwes- Director Varrlyn

Collateral management is the process by which organisations give or take guarantees as collateral against possible omission by the counterparty. On a daily basis Collateral Management departments calculate the risks taken by institutions in financial transactions. This is how they calculate the market value of outstanding transactions such as derivative and repo contracts, and decide whether (supplementary) guarantees in the form of money or securities should be claimed or granted.
In recent years exceptionally radical developments have taken place in the financial markets. Collateral Management fulfilled a crucial role in these developments. The bankruptcy of the merchant bank Lehman Brothers was evoked by the fact that counterparties claimed their supplementary securities. With the bankruptcy the shortcomings in the administering of counterparty risks and a great lack of transparency in the derivatives and repo market became apparent.

EMIR

In reaction to these developments the European regulation EMIR (European Market Infrastructure Regulation) was established in 2014. The objectives of the regulation are to create more transparency in the often complex bilateral (OTC) derivatives market and to make systemic risks more comprehensible. This is accomplished by among others mandatory reporting of all transactions and a mandatory clearing of derivatives through a central clearing party (CCP). When clearing OTC derivatives the collateral needs to be exchanged with the CCP during the duration of the specific derivate. This obligation consists of two parts: initial margin (to be paid when entering a contract) and variation margin (value development to be paid daily). Initial margin may be paid in securities, but variation margin must be paid in cash.

Collateral Management from back to front office activity

In a situation where returns are under pressure this obligation asks for a more inventive treatment of resources. What do you use as collateral: cash or securities and which collateral do you connect to which position? Besides risk management Collateral Management also becomes a return-defining factor and thereby shifts from the back to the front office. Traders will increasingly include the collateral exchange in their decisions.
Martin Defauwes is founder of Varrlyn, a boutique consultant in the area of system implementations for banks and Asset Managers. According to Defauwes, within many Treasury departments Collateral Management is currently the most important driver, besides regulation, for the adjustment of IT systems and processes. During the Collateral Management Event 2014 organised by IIR Defauwes will lead a Round Table session where he will address how organisations can adequately arrange their system architecture to deal with this changing force field.

Contact information:
Martin Defauwes Director Varrlyn
LinkedIn

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