Collateral management

In a narrow sense it involves managing of the collateral on behalf of the collateral taker. In a wider sense it concerns the advisory, monitoring and administration and trading activities concerning collateral and fee accounts, collateral debt obligations and or import and export trade for clients as well as for proprietary purposes. Collateral reduces the risk of counterparty default.
Financial institutions focus on the benefits of mitigating credit risk with counterparts through the regular giving and taking of collateral. They will only deal with counterparts who can support complex collateralised arrangements and manage large and diverse trade portfolios. They must also be able to handle daily margin calls according to tight schedules, evaluated according to credit rating related rules, and be backed up by strong reconciliation capabilities in the event of disputes. In managing collateral credit risk, interest rate risk and liquidity risk has to be dealt with. Collateral Management has become an essential part of a financial institution´s framework for risk and regulatory compliance. In January 2001 the International Swaps and Derivatives Association, Inc. (ISDA) calculated that between US$175-200 billion was pledged as collateral to protect credit exposure in the derivatives market. It is estimated that 20-25% of interest rate and currency swap trades are now covered by collateral.It has become a business practice in its own right and is recognised as the most important risk mitigating technique in the credit risk area, and is part of the Basel II guidelines.