Collateral Management in the OTC Market
By Marilyn Ramplin
CEO - Ramplin Capital and Hedge Fund Academy

ollateral management has become quite a buzz word. The hard lessons of the financial crisis of 2008-2009 continue to underscore the critical importance of identifying, managing and mitigating systemic risk. While SA weathered the crisis comparatively better than economies elsewhere, SA investors, asset managers and regulators share this concern.

Collateral requirements have long been routine for many exchange traded derivatives transactions, but in the over-the-counter (OTC) market they are often inconsistent, based upon non-transparent arrangements reached between the two parties. In the event of default, the parties may have little recourse than to liquidate any collateral held, but this is also highly dependent on having the correct derivatives agreement and sufficient collateral in place.

The dangers of under-managed counterparty risk emerged as a notable highlight of the global financial crises and the default of Lehman Brothers. With potential exposure often unknown, its destabilising impact helped spread disruption across financial markets. The experience served to illustrate the palliative uses of collateral to mitigate risk, therefore curbing runaway ripple effects.

Efforts to address counterparty risk, in particular, are focusing attention on the key role of collateral as a risk mitigation tool. 

Collateral management is rapidly becoming a vital operational and liquidity management function and it is likely to assume greater visibility as the result of heightened investor awareness and, where applicable, a regulatory shift to minimum collateral and liquidity requirements for banks under Basel III for all derivatives trades.

SA has also made a commitment under the G20 agreement to further reduce the risk in the market by putting in place a trade repository and central clearing platform for OTC derivatives and higher capital charges for bilateral trades under Basel III.

The liquidity requirements under Basel III is putting extra pressure on banks to look at alternative forms of collateral other than cash - as the opportunity cost of using cash is too high. The registrar of banks indicated that SA could suffer a liquidity shortfall in the region of R260bn. This will therefore result in a shift towards the use of more securities as collateral as more banks would like to hold onto their cash. This model could also be applied to exchange traded derivatives which would further ease the pressure on banks. 

Many buyside clients are realizing the impact of higher capital charges (CVA) and the impact this will have on the pricing of derivatives and the importance of managing the cost of derivatives by looking at the CCP model and bilateral collateral agreements, which would reduce counterparty risk and therefore the additional cost of the CVA added to the derivatives pricing.

About Ramplin Capital
Ramplin Capital is a consultancy business focusing on derivatives, risk management, collateral management, offshore investments, UCITS and hedge funds. Their clients inlclude banks, regulators, pension funds, insurance companies and hedge funds. Ramplin Capital have been recognized as a global leader and innovator in credit counterparty risk management, collateral and CCP advisory.

The Hedge Fund Academy is a specialist training business on derivatives, risk management, collateral management, offshore investments, UCITS and hedge funds.

Contact details

Marilyn Ramplin
CEO Ramplin Capital & Hedge Fund Academy
Tel: 082 771 4382 or 011- 783 9390
London +44 20 3286 8825
Cape Town +27 827714382
Email: marilyn@ramplincapital.com 
Web: www.ramplincapital.com or www.hedgefundacademy.co.za