Swap And Collateral Management Agreement
There is a wide range of collateral that can be used to guarantee credit risks at different levels of risk. The following types of guarantees are used by the parties involved: Independent Amounts: The independent amount is an additional amount of credit support that is required beyond the market value of the trading portfolio. The main objective of the independent amount is to cover changes in the market value of trades between collateral calls. The independent amount may be a fixed amount or a percentage of the nominal size of the portfolio. There is opposition to the provision of an independent amount, as it can have a negative effect on a company`s liquidity. The dominant form of guarantees is cash and government bonds. According to ISDA, liquidity accounts for approximately 82% of the guarantees received and 83% of the guarantees provided in 2009, which is broadly in line with last year`s results. Government securities account for less than 10% of the guarantees received and 14% of the guarantees provided this year, which corresponds to the end of 2008.  Other types of warranties are less used.
Call -Return Amounts: The amount of the guarantee that will be requested or returned. Collateral management has advantages. It can reduce potential credit losses and the use of capital, it can increase the number of transactions you make with a party, and can also reduce business spreads. You can also use other forms of collateral such as bonds. Depending on their credit quality and liquidity, they may be subject to a valuation percentage or a discount. Banks have long recognized that over-the-counter derivatives, such as swaps and options, can create credit risks for counterparties. This is why these products require an internal credit authorization. What causes credit risk? Percentage of valuation: This term is also called “haircut.” This is a percentage that reduces the market value of collateral. For example, security with a market value of $10 million and a valuation percentage of 98% are only accounted for as $9..8m for guarantees.
Valuation percentages protect the security taker from security value losses during the period between collateral calls. One way to reduce credit risk is to use a break clause. Bilateral break clauses allow both parties to break the swap on agreed future dates. If the swap is broken, the MTM value is exchanged and both parties can replace the agreement elsewhere. But you can improve the break clauses and further reduce the credit risk. That is the issue of collateral management. The main reason for the guarantee is the reduction of credit risk, especially in times of debt default, currency crisis and large hedge funds default. But there are many other reasons why the parties deprive each other of security: But with guarantees, if you fulfill the proper legal guidelines, you can terminate transactions and use guarantees as a refund.
If the value of the warranty is sufficient, your MTM gain is protected. Your credit risk has been reduced. Collateral management consists of several parts: Thresholds: the threshold is an unsecured credit risk that the parties are willing to accept before requesting guarantees. Ideally, thresholds are set at relatively low levels to maximize credit risk reduction. If you give security in cash, you will receive interest. If you take security in cash, you pay interest. In the documentation, it is normal to agree on the use of a night index rate such as EONIA. This risk may not be significant for short-term contracts. But for long-dated deals, it`s increasing.