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  5. OTC Derivatives Collateral Management: A Credit Risk Mitigation Technique Revisited

OTC Derivatives Collateral Management: A Credit Risk Mitigation Technique Revisited

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15 June 2009

Abstract

The practice of OTC derivatives collateralization has taken more than a few evolutionary steps at once, triggered by extremes of turbulence and high-profile credit failures. New levels of sophistication and effectiveness are required to master the activity and make its credit risk mitigation potential reality.

The rigors of the credit crisis have significantly strengthened the status of OTC derivatives collateralization. Mitigating counterparty credit risk has always been a necessity, yet current market turbulence and high-profile credit failures haven given the practice new relevance and urgency. Explosive year-on-year growth in collateralized OTC transactions testifies to this.

As risk managers undertake a rigorous assessment of their collateral management capabilities, they will find market practices have evolved materially. The range of eligible collateral has widened, then narrowed, credit terms are tightening, the frequency of margin calls is accelerating, and margining techniques are becoming ever more sophisticated. These changes are making fresh demands on the capabilities of collateral managers and systems.

In this report, OTC Derivatives Collateral Management: A Credit Risk Mitigation Technique Revisited, Celent provides an overview of OTC derivatives collateralization with regard to growth, growth drivers and conduct. Against the backdrop of these findings, the report identifies best practice features of OTC derivatives collateral management in terms of both organization and technology.

"Our analysis shows that, while the types of risks in collateralization are manifold, on a day-to-day basis, successful collateral management is primarily an operational risk management challenge," says Isabel Schauerte, Celent analyst and co-author of the report. "Overall, best practices are characterized by going beyond merely the technological and administrative aspects of managing collateral into a highly cohesive approach to integrating collateralization processes strategically into a firm’s trading and risk architecture," she adds.

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