Collateral Management Masterclass

Collateral Management

What is collateral? Collaterals simply are the set of assets, in the form of securities or cash, delivered as security by the debtor to the creditor to hedge the credit risk of the financial transactions agreed between two parties. In the event of a debtor’s default, the creditor has the right to keep the assets pledged as collateral to compensate for the financial loss suffered.

The practice of offering collateral, or “collateralizing” operations, has grown steadily in recent years, with the financial crisis of 2007-2008 resulting in further growth. The management of available collateral that may be used as security for debt thus becomes a strategic concern for the parties to mitigate the credit or counterparty risk.

You might be familiar with the collateral provided on loans, like a mortgage, where the banks or lending institutions have the right to take ownership of the house; if the debtor defaults on mortgage payments, the bank can take ownership of the house.

However, collaterals are not limited to loans; from an investment banker’s perspective, collaterals are also required in derivatives and securities financing transactions. In derivatives, if the trades are made Over the counter (OTC) that is directly between two counterparties, the basis and arrangements of collateral will be made by the terms on which both the counterparties have agreed, and if the trades are made on exchanges, listed derivatives then the arrangements of collateral will be made on the rules determined by the clearinghouses.

Now for securities financing transactions, collaterals are required for repurchase agreements, commonly known as Repos and Reverse Repos, where banks lend money among themselves or to the central bank for brief periods, usually overnight. Collaterals are also required in Stock Borrowing and Lending schemes, where stocks are borrowed and lent, for a maximum period of 12 months. A margin lending scheme that allows us to borrow money for investment purposes also requires collateral.

Ready to learn more, come learn with us.