Collateral management is a method of operating used by managers when they are dealing with collaterals. It includes monitoring, assuring and advising on collateral transactions (P.C.Harding, Ch.A.Johnson 2002,p.12). In a situation when a small or corporate bank doesn't possess the internal resources or the amount to set up its collateral management unit, it can always outsource these operations. Using the third party is recommended when each party is small (P.C.Harding, Ch.A.Johnson 2002,p.29).
The purpose of collateral management units
Collateral management units are dealing with (P.C.Harding, Ch.A.Johnson 2002,p.12):
- recording relationships in the collateral management system
- checking collateral received on the agreed mark to market frequency
- conducting special collateral projects
- asking for an initial margin if necessary
- coping with failures in delivering securities collateral and cash margin
- filing the agreed "haircuts" to collateral
- coordinating collateral valuations of sundry branches
- being involved in collateral agreement negotiation
- rechecking the same thing whether a margin call has been given from a counterparty
- coping with instances for collateral substitutions
Types of collateral
The two the most popular types od collaterals are bond and cash (M.Simmons 2019, p.7).
Cash collateral is usually given in British Pounds (GBP),US Dollars (USD) AND Euros (EUR). In a situation when firm's exposure is the same currency as the collateral from the counterparty, there is no foreign exchange (FX) risk. That is because there isn't any conversion to be made. Contrary, If the firm is in possession of the same USD exposure, although is given another currency as collateral, there is a risk of exposing the firm to FX currency rate movements. It might end with collateral having a lower value than the firm's exposure (M.Simmons 2019, p.7).
Bond Collateral happens when the borrower is offering his property or assets as a security measure to receive money from the lender. When the borrower id failing to give back the money, the person who lends it can retrieve it by acquiring the borrower's property or assets (M.Simmons 2019, p.7).
Examples of bonds:
- Fixed Rate Bond has a fixed coupon rate. It is also providing the lender with an unchanging fixed-rate throughout the bond's lifetime. Moreover, the first payment is often made one year after issuing the bond. Additionally, the price of the bond is going to change according to laws of supply and demand(M.Simmons 2019, p.10).
- Floating Rate Notes (FRN) is a bond, whose rates are based on a defined floating benchmark rate. The payments are made when coupon rates are changing. Some of those bonds are issued with repayment of capital at par and no payments of interest(M.Simmons 2019, p.11).
- Zero-Coupon Bonds is also a type of bond that is issued with repayment of the capitol at par. The most unusual feature of this band is the fact that is a non-interest-bearing bond. This type of bond is issued highly discounted from par(M.Simmons 2019, p.12).
- Bindseil U., Gonzalez F., Tabakis E., (2009), Risk Management for Central Banks and Other Public Investors, Cambridge University Press, United Kingdom
- Harding P.C., Johnson Ch.A., (2002), Mastering Collateral Management and Documentation: A Practical Guide for Negotiators, Pearson Education, Great Britain
- Simmons M., (2019), Collateral Management: A Guide to Mitigating Counterparty Risk, John Wiley & Sons, United Kingdom
Author: Witold Urjasz