Collateral management: the changing documentation landscape

Transcription

1 Collateral management: the changing documentation landscape Guy Usher, Partner, Derivatives and Structured Finance Tel: +44 (20) th Annual Optimising OTC Derivatives Operations in Fund Management Osney Media - 2 November 2011

2 What I will cover Over-collateralisation risk Uncleared trades Cleared trades Outsourcing options Client position

3 Exposure under standard ISDA Credit Support Documents English law Credit Support Annex outright transfer of collateral to counterparty fully exposed to counterparty for collateral return New York law Credit Support Annex security interest in collateral (so ownership remains with person providing it) but: assets held by collateral taker general right of collateral taker to rehypothecate English law Credit Support Deed as NY CSA but no rehypothecation allowed

4 Contributors and mitigants to overcollateralisation risk Contributors: initial margin (Independent Amounts) haircuts (Valuation Percentages) minimum transfers (on Return Amounts) timing factors Mitigants: value and call more often better quality collateral (lower haircuts) isolate initial margin from counterparty default

5 ISDA White Paper White Paper on Independent Amounts (IAs) Part I: issues (published October 2009) Part II: approaches (published March 2010) Purposes of IAs Risks of posting IAs Tri-party arrangements for IAs: isolation from counterparty s estate ability to get collateral back

6 Typical Structure / Documentation CSA (MTM only) Fund MTM Collateral CSA / CSD (IA only) Bank Custody Agreement IA Collateral IA Collateral Delivered following Event of Default Account Control Agreement IA Collateral Delivered following Event of Default Custodian

7 Operational/Custody Issues Two collateral streams to operate / manage per counterparty and fund Need reporting/on-line access to counterparty where the fund appoints the custodian Separate custody accounts needed for each fund and counterparty (where the fund appoints the custodian) Custodian s lien Who bears custodian risk? Replacement of custodian on credit impairment Termination of Custody Agreement/ACA

8 Control issues When can counterparty enforce the security? When can fund get sole control? Custodian will not get involved so it means selfcertification Financial Collateral Regulations issues around control

9 Uncleared trades EMIR: uncleared OTCs are to be marked-to-market on a daily basis and risk management procedures shall require the timely, accurate and appropriately segregated exchange of collateral (Article 8(1)) Dodd-Frank: includes obligations with respect to IAs for uncleared OTCs draft CFTC and Prudential Regulator rules for collecting IAs (broadly) end-users will have to post to Covered Swap Entities Covered Swap Entities will have to collect from each other

10 Amount of IA (US rules) CFTC rules Pre-approved model margin for at least 99% probability of price changes over a 10 day liquidation horizon (CCP is 5 days) proprietary models not allowed Alternative method (no model) 2.0 multiplier for closely approximate cleared OTC; or 4.4 multiplier for cleared futures Prudential Regulator rules Pre-approved model proprietary models are allowed Alternative method (no model) look-up table sets minimum IA as % of a swap s notional amount

11 Collateral types and timing (US rules) Collateral limited to: USD Cash US Treasuries senior debt obligations of US government-sponsored entities any form with determinable value only for non-financial end-users (CFTC) When it must be posted: IA must be collected on/before date of execution of the trade

12 Segregation (US rules) Right to segregation: obligation to notify the right to segregation Covered Swap Entities must require IAs posted by them to be segregated Segregation requirements: custodian must be independent of the collecting party neither the collecting party nor the custodian can rehypothecate or reinvest the collateral

13 Issues for cleared trades Account structures and segregation Margin requirements Documentation

14 Account structures and segregation CCPs require: separation of client and house positions CCPs offer: omnibus client accounts individual segregated client accounts (sometimes) omnibus segregated accounts CCP treats each account as separate: no netting between accounts of margin requirements no netting between accounts on default

15 Margining (1) Initial margin always paid to, and held by, CCP Variation margin is not held by CCP, but paid away under mirror trade Net margining each client will post gross margin to its Clearing Member Clearing Member can net margin to CCP with omnibus account structure

16 Margining (2) Clearing Member margin requirement determined by CCP no ability to challenge Client margin requirement based on amount to be posted to the CCP (possibly) plus additional amount (for Clearing Member protection against Client default) Eligible collateral for Clearing Members cash and (possibly) government securities (for initial margin) Eligible collateral for Clients clearers may permit additional types haircuts will apply

17 Margining (3) CCP only protects margin held by it, not: excess of gross over net margin Clearing Member add-ons ineligible collateral posted to Clearing Member Timing CCPs call Clearing Members intraday for margin settlement periods much shorter than under a CSA credit lines from Clearing Members may therefore be required

18 Documentation Clearing Member and Client: Clearing Agreement/Terms of Business OTC Clearing Addendum to Clearing Agreement (FIA) ISDA Master Agreement with modified CSA Back-up Clearing Member and Client Give Up Agreements Bespoke Margining/Collateral Management Agreements

19 Outsourcing Options Custodian as Clearer? Collateral Manager as Clearer? Collateral Manager or Clearer as Liquidity Provider? Collateral Manager as IA Custodian?

20 What about the client? Use of collateral manager /custodian? Selection of clearing model / clearer(s)? Decision to segregate cleared and uncleared? Ability to create liquidity lines? Risk Disclosures/Disclaimers

21 Collateral management: prospective documentation changes Guy Usher, Partner, Derivatives and Structured Finance Tel: +44 (20) th Annual Optimising OTC Derivatives Operations in Fund Management Osney Media - 2 November 2011