Risk Metrics
Figure 2: Cashflow at Risk Models Require the Integration of Multiple Source of Risk & Portfolio Components
the impact in the credit and liquidity risk profile of the firm counterparties approaching their rating triggers. Credit risk managers can work closely with the collateral managers to determine the counterparties that need changes in their collateral terms as market and credit conditions change. Collateral agreements reduce, but do not fully eliminate, counterparty risks. For instance, for collateral agreements that have a weekly or monthly margin call frequency, market movements may result in a large exposure between the time of the last collateral exchange and the time when default is determined and the trades are closed out. Many collateral agreements also have a minimum threshold below which no payments are made. The use of collateral transforms counterparty risk
Source: NQuantX LLC
since the financial crisis. Some of the benefits of establishing a collateralised relationship with a counterparty are the ability to facilitate more profitable business, a reduction in the cost of credit, as well as the possibility of freeing up trading lines and achieving savings in regulatory capital for regulated entities. Some of the key benefits from integrating collateral
management within the risk management team is the centralisation of the responsibility for monitoring changes in the counterparty risk exposures, as well as the evaluation of
Stages in the Collateral Management Process
into operational, settlement, market, credit, and legal risks that need to be clearly understood and quantified. For example, the collateral received/ posted can depreciate or appreciate in value during the close-out period introducing market
risk. Having a well-defined process of establishing ‘haircuts’ for collateral can minimize the market related risk of collateral held and posted. Most large derivatives market players have a collateral risk
policy in place. One of the items covered by the policy is usually the collateral management process, which comprises a series of steps where various groups within the trading firm must be involved (Table 2). A Collateral at Risk engine needs to take into account the
Table 2: Stages in the Collateral Management Process Groups Involved in Each Stage
Make the decision to enter into a collateralised relationship Credit Risk officer, business sponsor Negotiate the terms of the collateral agreement
Establish new agreement in collateral management system Collateral Manager Calculate collateral to be received or posted
Settlements
Collateral Manager, Credit Risk Officers, Business Sponsors, Lawyers
Market Risk, Credit Risk, Collateral Manager
Make collateral call and agree delivery & return amounts Collateral Manager Settle collateral receipts & deliveries
Update records to show changes in collateral balances
Reflect collateral holding in credit & liquidity risk management system
Collateral risk management Management reporting
worldPower 2010 Collateral Manager Collateral Manager, Credit Risk Officer
Collateral Manager, Risk Managers Collateral Manager, Risk Managers
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