Collateralized Banking

COLLATERALIZED BANKING
26th September 2013, Frankfurt

Christian Schmaltz, Aarhus University/ True North Institute
INSTITUTE
©Frankfurt–School.de
Agenda
1. Introduction
2. Overview
3. Operating Model
4. Collateral Planning
5. Capital Requirements
6. Risks of Collateral
7. Conclusion
8. Appendix
Optimierung des Collateral Managements/
Erfahrungen eines Lösunganbieters
Jörg Lindenberg/ Jan Eisenhardt, TXS GmbH
INSTITUTE 2
Timetable
Timetable
1. Introduction 09:00 – 10:30

2. Overview
3. Operating Model 10:45 – 12:15
13:15 – 14:45
7. Conclusion 15:00 – 16:15
8. Appendix
Erfahrungen eines Lösunganbieters 16:30 – 17:30
INSTITUTE 3
0. Glossary
Adj. Adjustments
A-L-based Asset -Liability-based
ALCO Asset Liability Committee
BB Banking Book
BCBS Basel Committee of Banking Supervision
BL Business Line
BR Business Risk
BS Balance Sheet
CB Central Bank
CC Countercyclical Buffer
CCP Central Counterparty
CCR Counterparty Credit Risk
CE-T1 Common Equity Tier 1
CL Credit Lines
CM Capital Market
CP Counterparty
CR-CRM
INSTITUTE
Correlation Trading - Comprehensive Risk Measure 4
0. Glossary
CP Counterparty
CR-CRM Correlation Trading - Comprehensive Risk Measure
CRD IV Capital Requirement Directive
CRR Capital Requirement Regulation
CR-SMM Correlation Trading - Standardised Approach
CSCP Corporate, Sovereign, Central Bank, Public Sector
CT Correlation Trading
CVA Credit Value Adjustment
DD Demand Deposits
DTA Deferred Tax Assets
EaD Exposure At Default
EBA European Banking Association
EEPE Expected Effective Positive Exposure
EL Expected loss
FI Financial Institutions
FTP Funds Transfer Pricing
G-SIB Global - Systemically Important Banks
IM
INSTITUTE
Interbank Market 5
0. Glossary
G-SIB Global - Systemically Important Banks

IM Interbank Market
IR Interest Rate
IRC Incremental Risk Charge
IRM Incremental Risk Measure
IRR BB Interest Rate Risk in the Banking Book
LCR Liquidity Coverage Ratio
LiqV LiquiditätsVerordnung
LT Long-term
LV Liquidation Value
MSRs Mortgage Servicing Rights
NSFR Net Stable Funding Ratio
OBS Off-Balance Sheet
OTC Over The Counter
P2 Basel II\ Pillar 2
P3 Basel II\ Pillar 3
SIV Special Investment Vehicle
SMM
INSTITUTE
Standardised Approach for Market Risk 6
0. Glossary
SIV Special Investment Vehicle

SMM Standardised Approach for Market Risk
Solv-D Solvency Directive
SPV Special Purpose Vehicle
ST Short-term
Std Standardised Approach
sVaR stressed VaR
TB Trading Book
TD Term Deposits
Uns Unsecured
VaR Value at Risk
WS Wholesale
INSTITUTE 7
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 8
1. Introduction
1. Academics
• Master in Business Engineering,
Karlsruhe, Germany
• Master of Arts in Economics, Paris I - Pantheon
• PhD Thesis:
„Optimal Liquidity Management in Banks“
• Assistant Professor Finance, Aarhus
Dr. Christian Schmaltz

• Internship, DaimlerChrysler, Singapore
Aarhus University, • Risk-Management Consultant,
True North Institute
Deloitte, Düsseldorf
2. Industry
Email: • Projects:
chsch@asb.dk
christian.schmaltz@tninstitute. eu
Commerzbank (CDS-Study)
HSH Nordbank
(Loan Commitments, Liquidity Stress Testing
• Risk Management Consultant,
KDB Krall Demmel Baumgarten, London
True North Partners, London
INSTITUTE 9
1. Introduction
• Collateralized Banking
3.Seminars
• Liquidity Management in Banks
• Basel III
• Market Risk Regulation
• German Banking Regulation
• Stress Testing
• Operational Risk Management
• Bank Management
Aarhus University,
Email:
chsch@asb.dk
INSTITUTE 10
1. Introduction
You You You You You You You
You You
1.Background
You You
2. Collateral
You background You
You 3. Seminar interest You
You You
INSTITUTE 11
Agenda
1. Introduction
2. Overview
A. Definitions
B. Collateral demand
C. Collateral supply
D. Collateral crunch?
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 12
2. Overview
A Definitions: Collateral pool and potential use
Use
Margining Funding R. Payt/ Lending
B III\ GC-
Settlt HF
OTC CCP IB ECB System LCR Pooling Sec Cash Assets Liab.
EUR
• Collateral lay on the asset side USD
Cash
(own collateral) or outside of the balance CB

sheet (received collateral). Banks Deposits
• Assets can be used as collateral, i.e. as cash Clearer
proxy (little market risk, little credit risk) for
Collateral
Govt Bonds
its value stability. CovBonds
Securities
CorpBonds
• The main use for collateral is: ABS
-Margining for derivative trading Mortgages
Secured
-Margining for payment & settlement Govt Guarantee
Loans
-Secured funding ECB-elig.
Unsecured
Others
- (LCR) Liquidity buffer
- Liquidity enhancement Non-collateral
- Cash: for lending
Received collateral
INSTITUTE 13
2. Overview
A Definitions: Custodians
Custodians: (a) main expertise: safeguarding, managing, re-using securities on behalf of third parties
(b) additional services like fund accounting, reporting, valuation, collateral trading, etc.
Asset Servicing Clearing & Collateral Mgt
Global Securities Tri- Prime brokerage
Global Custody Securities lending ... Collateral Mgt Margin mgt
clearing Party segregation ...
- Security - Platform to ... - Securities settlement - Effective use of collateral - Derivatives Margin Tri-
movement and match security (need access to many - Increase returns Management: pricing and Party
control lenders and markets) - Manage risk Margin computation/ agent
- Trade-date borrowers - Transaction - Minimize infrastructure expenses processing/ settlement
accounting (inl. - Customizing information/ reporting - Funding of trading activities of broker/ for repo and derivatives
Daily fund eligible - Optimize Collateral dealers
valuation, counterparties/ position and settlement - Collateral Agent: Collateral allocation and
participant securitie/ etc. because of single optimization
accounting) provider - Collateralized Deposits – allocate and hold
required collateral against reported deposits
(e.g. for public entities)
...
(commercial) Banks 1 1 1 1 1 1
Broker-Dealers 1 1 1 1 1
Insurance compagnies 1 1 1
Investment managers 1 1 1 1
Sovereign Institutions 1 1 1
Large custodians: 1. BYN Mellon, 2. JP Morgan Chase, 3. State Street, 4. Citigroup
Further reading: http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp68.pdf
INSTITUTE 14
Agenda
1. Introduction
2. Overview
A. Definitions
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 15
2. Overview
B Increased collateral demand by banks
Financial crisis
EMIR CCR B3 Profit pressure Direct regulatory requirement
+ + Secured + Ly Indirect regulatory requirement
+ extra yield
Margining funding Res

B III\ GC-
Settlt HF
EUR
Cash
USD
CB
Banks Deposits
Clearer
Collateral
Govt Bonds
CovBonds
Securities
CorpBonds
ABS
Mortgages
Secured
Govt Guarantee
Loans
ECB-elig.
Unsecured
Others
Non-collateral
INSTITUTE 16
2. Overview
Financial crisis
EMIR CCR B3 Profit pressure
+ + Secured + Ly
+ extra yield

B III\ GC-
Settlt HF
EUR
1. G20-summit, September 24-25, 2009, Pittsburgh: Cash
... Improving over-the-counter derivatives markets: USD
CB
1.1 All standardized OTC derivative contracts should be traded on
exchanges or electronic trading platforms, where appropriate, and Banks Deposits
cleared through central counterparties by end-2012 at the latest. Clearer
Collateral
1.2 OTC derivative contracts should be reported to trade repositories. Govt Bonds
Non-centrally cleared contracts should be subject to higher capital
requirements. CovBonds
Securities
CorpBonds
1.3 We ask the FSB and its relevant members to assess regularly
implementation (=> Progress reports) ABS
Mortgages
EMIR (European Market Infrastructure Regulation) Secured
1. Move 50% of OTC-deriv. to CCP => + XYZ initial margins Govt Guarantee
Loans
2. Margining for OTC-derivatives: => + 0.7 trill. € initial margins ECB-elig.
Unsecured
(origin’ed ≥ 16th August 2012) => + variation margin, but Others
+/- 0 on net demand for collateral
as one-way payment
Non-collateral
3. Higher capital requirements OTC
INSTITUTE 17
2. Overview
Financial crisis
+ + Secured + Ly
+ extra yield

B III\ GC-
Settlt HF
EUR
1. Interbank lenders substituted unsecured by secured lending to save Cash
regulatory capital (PDs of banks - => required capital - ) : USD
CB
Banks Deposits
Clearer
Collateral
Govt Bonds
CovBonds
Securities
CorpBonds
ABS
Mortgages
Secured
Govt Guarantee
Loans
ECB-elig.
Unsecured
Others
2. ECB replaced unsecured capital market funding
(esp. for banks of European periphery countries) Non-collateral
3. Borrowing on a secured basis saves funding cost.
INSTITUTE 18
2. Overview
Financial crisis
+ + Secured + Ly
+ extra yield

B III\ GC-
Settlt HF
EUR
1. All European banks must hold minimum liquidity buffer that exceeds Cash
(often) the current liquidity buffers (=> shortfall: 0.7 trill. €): USD
CB
LyBuffer + Inflows
LiqV LiqV
LyBuffer LCR
Banks Deposits
³1£
OutflowsLiqV OutflowsLCR - InflowsLCR Clearer
Collateral
2. Shortfall mainly results from larger outflow coverage and more Govt Bonds
conservative calibration.
CovBonds
Securities
3. Considers available collateral within the next 30 days CorpBonds
(=> requires collateral planning)
ABS
4. Encumbered collateral falls out of liquidity buffer. Mortgages
Secured
5. The liquidity buffer must consist of high quality liquid assets (HQLA), Govt Guarantee
Loans
i.e. CB-ON-deposits, Govt Bonds, CovBonds ≥AA-. ECB-elig.
Unsecured
Others
6. Buffer collateral should have been bought for liquidity generating
purposes and is owned by liquidity mgt.
Non-collateral
7. „Non-L1-≥30d – Repos“ and „ECB-≤30d-Repos“ improve LCR.
INSTITUTE 19
2. Overview
Financial crisis
+ + Secured + Ly
+ extra yield

B III\ GC-
Settlt HF
EUR
1. Banks face higher capital requirements for market (sVaR, IRM) and Cash
credit risk (CVA for OTC-derivatives) under Basel III as well as higher USD
liquidity buffers (LCR) and longer funding (NSFR). CB
2. Secured lending of cash earns a yield and is almost capital-neutral.
3. Secured lending of securities earns a yield and is almost capital Banks Deposits
neutral. Clearer
Collateral
Govt Bonds
CovBonds
Securities
CorpBonds
ABS
Mortgages
Secured
Govt Guarantee
Loans
ECB-elig.
Unsecured
Others
Non-collateral
INSTITUTE 20
Agenda
1. Introduction
2. Overview
A. Definitions
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 21
2. Overview
C How can increased collateral supply satisfy the increased demand?
More (+) Collateral supply
Direct 1. Govt + Government bonds

collateral
supply
2. Publ. ---
Low capital
3. CB + CB-deposits (unlimited allotment) requirement
Low haircuts
Raise in Indirect 4. Banks + Pooling + Covered bonds
collateral value collateral
(higher adv. Of supply
secured vs. + Pfandbriefe
unsecured
borrowing) + Collateral eligibility + Eligible collateral
+ Collateral optimisation + mobilised collateral

(enterprise-wide collateral mgt“)
- From back => front office
- Strategic use of collateral
- vendor softare for collateral inventory mgt-
+ Collateral re-use and transformation

• re-use of collateral (=> collateral flows):
(1) Security lending, (2) Repo, (3) Collat. swaps
Pension funds, incurance companies, investment
funds: (1) lend out securities to offset
custodian‘s fees or (2) raise cash to fund
collateral or (3) meet variation margins,
Collat. swaps exchange low- to high quality coll.
Source: CGFS Asset Encumberance (2012), p. 19 ff.
INSTITUTE 22
2. Overview
C Collateral supply: eligibility matrix
Central Bank Repo\ CCP

Borrowing Eurex Repo LHC Clearnet Initial Margin
€GCPlus Basket No 1
€GCPlus Basket No 2
ICE Clearing Europe

Payt/ Settl Systems
Repo Clear € GC
Eligibility Matrix
ECB Ext Basket
Eurex Clearing
Equity Basket
LCH Clearnet
CME Europe
Eurosystem
ECB-Basket
EMIR OTC
B3\ LCR
SNB
BoE
Cash 1 1 1 1 1 1 1 1 8
Govt 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 15
CB 1 1 1 1 1 1 1 1 1 1 1 11
Debt Public, Non-Govt 1 1 1 1 1 1 1 1 1 1 1 11
instruments CovB 1 1 1 1 1 1 1 1 1 1 1 11
Marketable CorpB, Banks 1 1 1 1 1 1 1 1 8
Assets CorpB, Non-Banks 1 1 1 1 1 1 1 1 8
ABS 1 1 1 1 1 1 6
Equities 1 1 2
Money market funds 1 1 1 3
Gold 1 1 2
Non- Loans 1 1
marketable Non-maretable RMBDs 1 1 2
10 8 6 10 9 7 4 6 1 4 7 1 8 3 2 2
Source: ECB, Collateral eligibility requirements: a comparative study across specific frameworks, July 2013, p. 54f.
Cash: includes term deposits from eligible counterparties
INSTITUTE 23
2. Overview
C Collateral supply: haircuts
Haircuts (= initial margin)

for OTC-initial margining (regulatory std‘ed approach).
1. Haircuts is a proxy for how different to asset

is compared to cash (HC=0).
2. Haircuts are lowest for public issuers and
covered bonds.
3. They are highest for structured credit
products.
4. Haircuts vary across time and depend on the
market circumstances.
1. Haircuts for public issuers and covered bonds are aligned to market
haircuts.
2. Haircuts for equity and gold are substantially higher.
INSTITUTE 24
2. Overview
C Collateral supply: re-employability
Re-employability is crucial to leverage collateral supply.
Ownership Re-employability CCP1 OTC2
Is transfered to the No additional agreement

Repo/ one that receives on re-use necessary
Security collateral ÞOwner can do
Lending whatever she wants
„re-use“
remains with Explicit agreement from • Rehypothecation allowed for: • Free rehypothecation of VMt
pledging party pleding party is necessary (1) Particular investments: cash • No rehypothecation of
for re-employment or highly liquid securities (with IM0,except if (a.o.):
Margining => „rehypothecation“ low market & credit risk) - collected from buy-side
(IM0, VMt) (2) Particular counterparties: financial and non-financial firms
CB/ banks/ custodians and if (no broker-dealers !)
fund seggregation is ensured - only to hedge the respective
derivative position
- ...3
Collateral No: Yes:

absorbed Fair degree of flexibility (Large!) Broker-dealer
in silo? to re-invest and to keep IM0 absorbed.
floating across the Other IM0: maximum
financial system. 1xrehypothecation for
hedging only.
1) ESMA, EMIR\ Draft regulatory technical standards on CCP requirements, Chapter XI Investment Policy, §45-49
2) BCBS, Margin requirements for non-centrally cleared derivatives, 2013, principle 5 & related recommendations.
INSTITUTE
3) Complete requirement list is on next slide.
25
2. Overview
C Collateral supply: re-employability
Re-employability is crucial to leverage collateral supply.
... OTC2
Repo/
Security ...
Lending
• Free rehypothecation of VMt

• No rehypothecation of IM0,except if:
1. Collected from buy-side financial and non-financial firms
(no broker-dealers !)
2. explicit written agreement of pledgee
3. Treated as „customer assets“
Margining 4. If invested => also treated as „customer asset“ and seggregated at third party
... 5. Only invest to hedge the respective derivative position
(IM0, VMt) 6. IM is protected against double default of IM-collector and third party
7. Third party cannot re-hypoth.
8. Customer to be informed on any rehypothecation
9. Third party to be EMIR-regulated
10. Customer and third party not of same group
11. IM-collector and 3rd party must record compliance
1) ESMA, EMIR\ Draft regulatory technical standards on CCP requirements, Chapter XI Investment Policy, §45-49
2) BCBS, Margin requirements for non-centrally cleared derivatives, 2013, principle 5 & related recommendations.
INSTITUTE 26
Agenda
1. Introduction
2. Overview
A. Definitions
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 27
2. Overview
D Collateral crunch?
Source: Department of the Treasury, US, July 2013
INSTITUTE 28
2. Overview
D Collateral crunch?
Source: Department of the Treasury, US, July 2013
INSTITUTE 29
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 30
3. Operating model
Evolution of collateral management
Future
Current
Past
time
Positioning Collateral accountant Collateral manager Collateral optimizer
Philosophy Supporter Enabler Driver
Objectives & Ensure correct collateral flows + Enhance collateral stock + Optimize collateral pool
Principles Report collateral stock + Ensure collateral adequacy + Inhouse collateral market
Ancillary back office function Middle office function Front and middle office
Organisation One CM per product line Several CMs across subsidiaries One centralised CM
Mainly manual Electronic, but flow breaks End-to-end

Collateral Product- and entity specific between systems Integrated across products
process Product-specific
INSTITUTE 31
3. Operating model
Objectives and Principles
Objectives of collateral management:
1. Ensure required collateral from margining, LCR, MaRisk and PfandbriefG.

2. Optimize collateral pool by collateral substitution.
3. Mobilise available assets:
Generate additional liquidity by mobilising liquid assets so far unused for
liquidity generation (e.g. bank book bonds).
Generate additional liquidity by transforming low liquid assets into high liquid
assets (e.g. repo, collateral swaps)
Generate extra revenues by security lending.
4. Acquire additional external collateral (reverse repo, security borrowing) if
needed.
=> To align the objective of extra revenues and additional liquidity

=> Require funds transfer pricing that allocates the generated benefits to P&L of
collateral management.
INSTITUTE 32
Agenda
1. Introduction
2. Overview
3. Operating Model
A. Collateral process
B. Collateral governance
C. Collateral profit
D. Collateral cost (transfer prices)
7. Conclusion
8. Appendix
INSTITUTE 33
3. Operating model
A Collateral process
0. Collation:
0.
Collation • Collateral agreement/ documentation:
Rules to exchange collateral with counterparty
• Which collateral is acceptable?

6. 1. • Frequency of margin calls
Mitigation Allocation • Haircuts per collateral type
• Valuation method
• Conditions for re-hypothecation/ re-use
• Close out
• Termination clauses
1. Collateral allocation:
Which collateral to be used for which deals?
• Eligibility of collateral to counterparties
• Borrower rating from CRA
5. 2. • Maturity and record date
Reconciliation Calculation • Required value to be collateralized
• Lender ranking
• Haircut to be applied
• Concentration limits to be applied
2. Collateral calculation: how much collateral is

required for a certain position?
• Exposure to be covered (PFE, VaR, ...)
4. 3. • Automatic market data feed for MtM-valuation
Reporting Evaluation • Revaluation of collateral
• Margin calls (if any) if exposure > (1-HC)*MtMColl
INSTITUTE 34
3. Operating model
3. Evaluation:
0.
Collation a) Allocates collateral that needs to be allocated:
Optimizing:
- system finds most efficient allocation
(posts cheapest collateral that is still eligible,
6. 1. covers all margin calls)
Mitigation Allocation - Minimize number of transactions by netting
margin calls
b) Allocates (or proposes) collateral that could be

allocated (used) to generate extra revenues
Optimizing:
- Knows revenues to be earned by SecLending,
Repoing, collateral swaps, etc. and compares
potential P&L of these transactions
- Optimzes across product lines
5. 2. (OTC-trading, CCP-trading, Repoing,
Reconciliation Calculation SecLending, ...)
- Optimizes across entities
4. Reporting:
• External reporting to counterparties:
- margin calls, re-use of collateral, valuation,
reconciliation
• External reporting to regulators:
4. 3. - (EBA) asset encumbrance
Reporting Evaluation - ...
• Internal reporting to business lines:
- use and P&L of collateral
INSTITUTE 35
3. Operating model
5. Reconciliation: has collateral actually be

0. allocated and cycle be (successfuly) completed?
Collation • expected colalteral received?
• confirmation that posted collateral has been
received?
• In case of discrepancies (under-/
6. 1. overcollateralization) => resolving algorithm
Mitigation Allocation
6. Mitigation of risks inherent in collateral
management process:
• Operational risk:
- Manual intervention
=> automatize as much as possible
=> add control mechanisms
- Ad hoc procedures to integrate new processes/
products/ clients/ staff/ ... => establish
standardized processes
5. 2. • Settlement risk:
Reconciliation Calculation - expected collateral is not settled
=> use efficient and robust payment & settlement
systems incl. backup system
• Market risk:
- fluctuating market prices affect collateral value
=> collateral pool can be hedged, but entity must
also ensure that the hedge P&Lis the source to post
collateral to counterparties
4. 3. • (Market) Liquidity risk: liquidation of collateral is
Reporting Evaluation difficult if thin market
• Concentration risk: dominant issuer (firm/
sovereign/ asset class) => concentration limits
•Legal risk: cros-border might involve different laws
INSTITUTE 36
3. Operating model
A Collateral process for an individual collateral
0. Can be inhouse or outsourced (e.g.

Collation Custodian)
A) Acquire
collateral
B) Register Entering the collateral space

collateral
1. Allocation: product-specific specialists

Collateral
E) Encumbered (1-X %) of time
Manager
X % of time Collateral leg Cash leg
Lend
Lifecycle of collateral
E.1) Block collateral E.2) Transfer collateral Book initial proceeds

C) Unen- collat.
+
cumbered
Return
E.4) Free collateral E.3) Re-obtain collateral Book final proceeds
collat.
Use-specific:
• Security lending
• Funding repo
• Derivative margining
• Securitised issues (Covered bonds, Pfandbrief)
• LCR
E) De-register
collateral Leaving the collateral space
F) Dispose
collateral
time
INSTITUTE 37
3. Operating model
A Collateral management process matrix
To use IMM for CVA Repo SecDeals Trading

=> Minimum requirements for CM, see CRR, 㼲287
Daily collateral Bilateral Tri-Party CCP Bilateral Custodian OTC CCP LCR Pfandbrief
Products
management Collateral-related
tasks 30% 30% 40% 5% 95% >50% 0-50%
steps for inidividual deal
Documentation
Agree on collateral type, CCP- CCP- With Ly With cover

C) Collateral inventory management
amount and re-use rules rules Mgt pool mgt

1.
D) Reporting (collateral cockpit)
Initiation
B) Collateral risk management
To Ly To cover
Transfer collateral IM0- IM0
Mgt pool
A) Data management
Receive collateral IM0+

Custodian
2. During Margin management Tri-
CCP CCP
lifetime (Calculation, Call, Report) Party
From Ly From cover

Return received collateral
Mgt pool
3. At
maturity
Receive posted collateral CCP CCP
or
Liquidate received collateral

At default Creditor Creditor CCP Creditor CCP
Claim unsecured part
INSTITUTE 38
3. Operating model
A Collateral management process matrix
To use IMM for CVA

=> Minimum requirements for CM, see CRR, 㼲287
Daily collateral management tasks
• Update haircut and • Monitor collateral • Settle manufactured • Internal:

eligibility matrices limits of collateral coupons and dividends - daily margin reports
pool on VM and IM, posted
and received
- Source of collateral
[Repo-, Margining,
• Update changes in •Track re-use of posted • Forecast collateral own, SecBorrowing]
re-use policies for collateral demand and supply - Use of collateral
C) Collateral inventory management

received collateral i) In case of excess [Repo, SecLending,
supply: start using
D) Reporting (collateral cockpit)

Pfandbrief, Margining,
collateral or
B) Collateral risk management
Clearer, ]
deleverage - Margin call disputes:
• Update changes in • Track collateral ii) In case of excess size, aging, cause of
margin models concentration demand: margin call disputes
(methodology, generate new
A) Data management
• Trends
parameters) collateral (internally •At least quarterly to
or exeternally) senior mgt
• Automatic collateral • Actual & passive P&L
• Ensure consistent substitution
and reconciled data of collateral pool
• Automatic collateral • Collateral forecast
base to calculate selection
margins and actions
• Automatic
identiifcation of
• Track changes on revenue opportunities • External: Asset
how counterparties encumbrance (=> see
can re-use collateral. EBA-discussion paper)
INSTITUTE
3. Operating model
A Collateral management process: regulatory minimum requirements
CRR, 㼲287
(if use IMM for CVA)
1. Calculate margin calls (=> revalue exposure [loan volume, drivative price] and collateral value)
Margin calls 2. Make margin calls
3. Manage margin call disputes
4. Daily margin reports on (i) initial and (ii) variation margins received and posted
1. Controlling data integrity to calculate margins

Data 2. Ensure consistent and reconciled data base
management
1. Track re-use of posted collateral

Re-use of posted 2. Track changes in rules how counterparty can re-use posted collateral
collateral 3. Asset type of collateral reused and way of reuse (instrument, term, credit quality, maturity)
Concentration 1. Track collateral concentration

risk of own
collateral
1. Type and volume of collateral received and posted

Internal 2. Margin call disputes: size, aging, cause of margin call disputes
reporting 3. Trends
4. At least quarterly to senior mgt
1. Asset encumbrance (=> see EBA-discussion paper)

External
reporting
INSTITUTE 40
3. Operating model
A Collateral management process: key challenges
• There should be a generic data model that fits all deals.

Harmonized • The data model is split into 3 parts:
data structure (i) Deal-independent (information that every deal has)
(ii) Instrument-dependent (information that are specific to the instrument)
Cross-product • Maximum netting is realized if margining is managed across products.

collateral
management
Harmonized • Harmonized processes reduce operational risk and monitoring cost.
processes
1 global • Collateral function per product group (e.g. OTC-derivative collateral function, Exchange traded deriatives
collateral function, Repo collateral function, Securities lending collateral function) are operational [more
collateral potential errors, higher maintenance cost] and economically inefficient [multiple infrastructure, probably
function no margin netting across product lines].
Computation of • Ability to calculate robust initial margins based on a transparent methodology

initial margins
• Systems with Straight-Through Processing (STP) to avoid manual steps
End-to-end • Exception based management to automatically prioritize human intervention
Own Business • Move from back office/ aincillary function to strategic business line
practice
• Small banks are likely to outsource CM to Tri-party agent or vendor as amortisation of large fixed cost for
Outsourcing CM CM-business line requires critical mass on operations.
Enhance • Establish collateral management P&L

revenues
INSTITUTE 41
3. Operating model
A Collateral management process: key challenges
Funds Transfer Pricing to

incentivize collateral usage?
Source: Roland Berger Strategy Consultants; RBSC Collateral Management Executive Survey 2012
INSTITUTE 42
3. Operating model
A Collateral management process: unified collateral management
Collateral type ( ) and collateral usage ( ).
Assets Liab.
Cash Repo liability
Received OTC-Trading assets OTC- Trading liab.
collateral Ex-Trading assets Ex-Trading liability
1 Govt Sec Govt Sec
Repo CovB CovB Repo
collateral CorpB CorpB collateral
ABS ABS
2 Cash Cash
OTC- Govt Bond Govt Bond OTC-
Trading Cov Bond Cov Bond Trading
CorpB CorpB
collateral Equity Equity collateral
Gold Gold
3 CCP- Cash Cash
Govt Bond Govt Bond CCP-
In many Trading DevB/ CB DevB/ CB Trading
Other Sec1 Other Sec1
Collateral
organisations collateral collateral
there are Gold Gold
Govt Bond Govt Bond Unsecured
collateral 4 Sec Sec
collateral
pools per Deals3 Other Bonds Other Bonds Deals3
funding
product line. 5 Pay-/2 Govt Bond Govt Bond
Pay-/
Settlem. Settlem. 2
6 Cash
CB deposits
LCR GovB LCR
Collateral CorpB Collateral
Equity
RMBS
7 Surplus cover
Public Sect. Pfandbrief
Pfandbrief Ship
Collateral Aircraft Collateral
Mortgages
Non-coll.
1) „transferable securities and money-market instruments with: (i) low credit risk, (ii) low market risk, (iii) active diversified repo market,
(iv) reliable pricing data“, 2) For intraday and overnight central bank credit.3) Pure security transactions, no cash involved (e.g. SecLend, Collateral swaps)
INSTITUTE 43
3. Operating model
A Collateral management process: unified collateral management
Assets Liab.
Cash Repo liability
Received.\ OTC-Trading assets OTC- Trading liab.
Received collat.\ Re-use
No re-use Ex-Trading assets Ex-Trading liability
1 2 3 4 5 6 7
Govt Sec Govt Sec
DevB/ CB DevB/ CB
CovB Sec Payt/ Cover CovB

Repo OTC CCP LCR
Collateral
Deals Settl. Pool
Unsecured
collateral
funding
CorpB CorpB
Equity Equity
Gold Gold
Mortgages
Public Sect.
Ship
Aircraft
Non-coll.
• Collateral should be managed in one pool across product and business lines.
• Collateral users (Repo, SecDeals, LCR, Trading) borrow collateral from the pool and the collateral is blocked/ encumbered
during the time of the use (like capital for P&L-risk).
• Collateral providers (Reverse repo, SecDeals, Trading) lend collateral to the pool.
• The collateral pool does not distinguish owned and received collateral, but only „usable“ and „not usable“ collateral.
INSTITUTE 44
3. Operating model
A Collateral mgt process: major hurdles for a unified collateral management
1) Organisational: Govt Sec Assets Liab.

- Some product lines started unsecured and Cash Repo liability
gradually became secured or gradually
substituted the unsecured part OTC-Trading assets OTC- Trading liab.
(interbank borrowing, derivative trading) Ex-Trading assets Ex-Trading liability
- CM-function is decentralised to best serve 1 GovtB
local clearing and settlement requirements Repo CovB Repo
collateral CorpB collateral
ABS
2. Regulatory: 2 Cash
- Regulation is product-oriented, collateral OTC- Govt Bond OTC-
is a subcomponent, e.g.: Trading Cov Bond Trading
- Strengthening repo clearing and settlement CorpB
collateral Equity collateral
arrangements Gold
- Margin requirements on Non-OTC-deriv. 3 CCP- Cash
Govt Bond CCP-
- Margin requirements for CCP-derivatives
Trading DevB/ CB Trading
Other Sec1
Collateral
collateral collateral
3. Counterparty-specific collateral use: Gold
- The potential use of received collateral Unsecured
4 Sec Govt Bond Sec
collateral
might be counterparty-specific Deals3 Other Bonds Deals3
=> difficult to handle within 1 product line funding
5 Pay-/ Govt Bond
Pay-/
and even more difficult to handle across Settlem. 2 Settlem. 2
product lines 6 Cash
CB deposits
4. Local tax treatment: LCR GovB LCR
Collateral CorpB Collateral
- Taxation of return from received/ posted Equity
collateral might be location-specific RMBS
7 Surplus cover
5. Product-specific IT-systems: Public Sect. Pfandbrief
Pfandbrief Ship
Product-specific trading platforms imply Collateral Aircraft Collateral
product-specific collateral modules. This Mortgages
reinforces the product-specificity. Non-coll.
INSTITUTE 45
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 46
3. Operating model
B Collateral Governance
Potential governance structure:

- Short-term\ secured trade repo/ reverse repo , security lending/ borrowing, collateral swaps => collateral
- Long-term secured issues Pfandbriefs => cover pool
- Derivatives trades derivatives => margining
- Liquidity management steers the liquidity buffers (LCR, strategic liquidity reserve).
- All their activities involve collateral. Therefore, they interact with collateral management.
Group Treasury Capital Markets
Specialists
ALM
ALM Europe Fixed Income Equity Derivatives
Americas
Funding desk/ Short-term Long-term

Liquidity Management
Security and Collateral Sec Un-

Secured Secured Unsecured
Management Lending secured
INSTITUTE 47
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 48
3. Operating model
C Collateral profit
Collateral pool
Compliance Extra revenues or extra collateral Lower funding cost
EMIR-derivative Sec Lending, Sec Lending, Tri-party

LCR Repo Pfandbrief
trading uncollateralized collateralized repo
Cash 3rd party is

Lend highly Highly against Mgt of
HQLA VMt, IM0 Against Collateral
liquid security less liquid security cover pool
security manager
Bank CP Bank CP Bank CP

Cash
Bank CP
Security
Fee/ interest Cover

Manufactured pool PB
payments
3rd
Encumbered
Party
Daily MtM
Daily margining
[Euribor – Eurepo] Senior unsecured

5-15 bps 5-10 bsp Euribor - Eurepo
- Tri-party-fee - PB-curve
INSTITUTE 49
3. Operating model
C Collateral profit
Collateral pool

LCR Repo Pfandbrief
Cash 3rd party is

Security against Mgt of
HQLA VMt, IM0 One-way Against Collateral
security cover pool
security manager
How do you plan to increase collateral income ?
Source: Presentation Michael Cyrus, DekaBank Source: Roland Berger Strategy Consultants;
RBSC Collateral Management Executive Survey 2012
INSTITUTE 50
3. Operating model
C Collateral profit
Collateral pool
Extra revenues or extra collateral
Sec Lending, Sec Lending,

uncollateralized collateralized
INSTITUTE 51
3. Operating model
C Collateral profit
Collateral pool

LCR Repo Pfandbrief
Cash 3rd party is

security cover pool
security manager
INSTITUTE 52
3. Operating model
C Collateral profit
Collateral pool

LCR Repo Pfandbrief
Cash 3rd party is

security cover pool
security manager
INSTITUTE 53
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 54
3. Operating model
D Collateral cost (transfer prices)
Central
Front Office Front Office
Management Units
Loan, Notional Liquidity Notional Deposit,

unsecured Management unsecured
FTPunsecured FTPunsecured
[Liquidity user] [Liquidity provider]
Loan, Notional Notional Deposit,

secured secured
(e.g. FTPunsecured (e.g. Repo)
Reverse repo) FTPunsecured
[Liquidity user] [Liquidity provider]
Collateral Collateral Collateral

[Collateral provider] [Collateral user]
Management
FTPCollateral FTPCollateral
FTPReverse Repo = 100% × FTPUnsecured FTPReverse Repo = HC × FTPUnsecured + (1 - HC) × FTPSecured

- (1 - HC ) × ( FTPUnsecured - FTPSecured ) FTPCollateral
= HC × FTPUnsecured + (1 - HC ) × FTPUnsecured
- (1 - HC ) × ( FTPUnsecured - FTPSecured )
= HC × FTPUnsecured + (1 - HC ) × FTPUnsecured
+ (1 - HC ) × FTPSecured - (1 - HC ) × FTPUnsecured
= HC × FTPUnsecured + (1 - HC ) × FTPSecured
1) FTPCollateral = (1-HC)*(FTPunsecured - FTPsecured)
INSTITUTE 55
3. Operating model
INSTITUTE 56
3. Operating model
INSTITUTE 57
3. Operating model
Central
Management Units

unsecured, Management unsecured
3M FTPunsecured = 0.75% FTPunsecured = 0.75%

secured secured
(e.g. FTPunsecured = 0.75% (e.g. Repo,
Reverse repo, FTPunsecured 3M, 20% HC)
3M, 20% HC)

Management
FTPCollateral = 80%*(0.75%-0.375%) FTPCollateral
FTPReverse Repo = 20% × 0.75% + (1 - 20%) × 0.375%

FTPReverse Repo = 0.45%
= 0.45%
Note that a collateral has two properties:

1.) It is funded.
2.) Collateral property (e.g. near-cash substitute with low market risk and highly liquid)
The price for 1.) is FTPUnsecured. The benefit is receiving the coupon.
The compensation for 2.) is FTPCollateral.
Borrowing the collateral costs 2.) as the economic owner is still enjoying the coupon, but must also fund it.
INSTITUTE 58
3. Operating model
Incentive alignment to mobilise the collateral pool
Bank A
coupon % Collateral Unsecured runsecured
Other Assets Other funding
Bank does mobilise collateral Bank does not mobilise collateral
Encumbered Bank A Bank A

Cash Repo 1€ Cash Unsecured 1€
1/(1-HC) € Collateral Unsecured 1/(1-HC) € Collateral Unsecured
Other Assets Other funding Other Assets Other funding
[0 - 1.875%] × 1 [0 - 2.25%] × 1
Value
(group level) 1 [0.375%] × 1 1
+ [coupon % - r unsec ured ] × + [coupon % - r unsec ured ] ×
(1 - HC
C) (1 - HC )
Δ saving IR-expenses
INSTITUTE 59
3. Operating model
Internal
Owner Ly Mgt
Notional Notional Un-
Internal Owner secured
=
Collateral Manager Colla-
teral Collateral Mgt
=> Internal owner has an
incentive to put collateral
„at work“
Bank A
Collateral Unsecured
Other Other
Assets funding
Internal
Owner Ly Mgt
Internal Owner Notional Notional
temporarily lends Un-
collateral to secured
collateral manager
Colla-
=> Collateral manager has Collateral Mgt
teral
an incentive to put
collateral „at work“ Collateral
FTPCollateral
INSTITUTE 60
3. Operating model
Internal
Owner Ly Mgt Bank A
Notional Notional Un- Collateral Unsecured
secured
Colla- Other Other
teral Collateral Mgt Assets funding
Collateral
FTPCollateral
Bank does mobilise collateral Bank does not mobilise collateral
Ly Mgt Ly Mgt
Notional Notional Notional Notional Un-
Cash Repo Cash
FTPunsecured FTPunsecured secured
same
Notional Notional Un- Notional Notional Un-
secured secured
FTPunsecured FTPunsecured FTPunsecured FTPunsecured
Colla- Colla-
teral Collateral Mgt teral Collateral Mgt
Collateral Notional Collateral Δ=FTPCollateral
Repo
FTPCollateral FTPCollateral FTPCollateral
Δ=FTPCollateral and allocated to the collateral manager‘s P&L !!,

not to the funding desk !!!
INSTITUTE 61
3. Operating model
• The internal transfer price of a repo consists of a FTPUnsecured for the cash leg and a FTPCollateral for the security leg.
Incentivising the mobilisation of collateral:
• Only actual use is rewarded:

=> Repoable securities have an unsecured transfer price.
=> Repoed securities have a HC*FTPunsecured + (1-HC)*FTPSecured transfer price.
• The responsible for collateral allocation should be P&L‘ed:
=> If it is the collateral owner => has an interest to reduce the unsecured funding cost of its collateral
=> If it is the collateral manager => he borrows the collateral from the owner against a fee
and subsequently seeks to recover the fee by allocating the collateral to the best internal and external use.
INSTITUTE 62
3. Operating model
Central
Management Units


secured secured
3M, 20% HC)

Management
Security Collateral Collateral Security

borrowing lending
FTPSecurity borrowing FTPSecurity lending
INSTITUTE 63
3. Operating model
Central
Management Units


secured secured
3M, 20% HC)

Management
Collateral swap
Security Collateral Collateral Security

borrowing lending
FTPSecurity borrowing FTPSecurity lending
INSTITUTE 64
3. Operating model
Central
Management Units

Capital P&L-risk IR-Swap

Buffer trade,
RoE uncollateralized
Capital IR-Swap,
Buffer P&L-risk collateralized
RoE
Collateral Management
VMt - Ly line VMt
Cash buffer
FTPLy Line
Securities
Collateral IM0 IM0
Collateral Collateral
provider FTPCollateral
FTPCollateral
INSTITUTE 65
3. Operating model
If collateral mgt also provides all back-office tasks (clearing, settlement).
Central
Management Units

Capital P&L-risk IR-Swap

Buffer trade,
RoE uncollateralized
Capital IR-Swap,
Buffer P&L-risk collateralized
RoE
Collateral Mgt acts as

„Internal CCP/ custodian“ Collateral Management FTPLy Line
Cash buffer
VMt
Securities FTPCollateral for IM0

Collateral Collateral
provider Collateral IM0
FTPCollateral Valuation
Margin calls
INSTITUTE 66
3. Operating model
Example: transfer prices with collateral premium FTPCollateral
Exemplary transfer prices for a bank that:

(1) funds senior unsecured at EURIBOR + 0 bps AND
(2) Funds repos at Eurepo + 0 bps
Asset Liquidity HC TPInterest rate FTPUnsecured FTPCollateral

Horizon
Asset N XxWeeks HC xW-EONIA xW-Euribor – xW-EONIA (1-HC)*[xW-Euribor – xW-Eurepo]
Govt Bonds 1W 2% 1W-EONIA 1W-Euribor – 1W-EONIA (1-2%)*[1W-Euribor – 1W-Eurepo]
Covered Bonds 2W 5% 2W-EONIA 2W-Euribor – 2W-EONIA (1-5%)*[2W-Euribor – 2W-Eurepo]
CorpB 1M 7% 1M-EONIA 1M-Euribor – 1M-EONIA (1-7%)*[1M-Euribor – 1M-Eurepo]
Non ECB 1M 100 1M-EONIA 1M-Euribor – 1M-EONIA 0

%
INSTITUTE 67
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 68
4. Collateral planning
Collateral supply Collateral demand
Product line Collateral providers Collateral pool Collateral users
Repo [cash leg] Repo [security leg]
Repo
Reverse repo [security leg] Reverse repo [cash leg]
Derivative OTC: (IM0)1, VMt OTC: IM0, VMt

Trading CCP: VMt CCP: IM0, VMt
Uncollateralized security borrowing
Sec Uncollateralized Security lending

Transaction
Collateralized security lending, Collateralized security lending,
collateral leg lending leg
LCR LCR
Payt/ Received payment/ settlement Posted payment/ settlement

Settlt collateral collateral
Pfandbriefe Cover pool for Pfandbriefe
Note: collateral that is used does not

leave the collateral pool.
It just change its status from
unencumbered to encumbered!!
Collateral as of today
Collateral forecast
1) Very restrictive re-hypothecation of IM0 in OTC-derivative trading.

INSTITUTE 69
Objective: ensure sufficient unencumbered collateral at every point in time
Unenc t +1 = Coll t +1 - Enc t +1

= Coll t + DColl t +1 - [ Enc t + DEnc t +1 ]
Expected evolution
of collateral buffer
Expected evolution
Enc0 Expected evolution
(demand) of encumbrance
Collateral0
(supply) Unenc0
(Excess
supply) Minimum
collateral buffer ?
time
(A) There are two key figures to be monitored on the aggregate level:
1. Evolution of collateral buffer
2. Evolution of encumbrance rate
(B) Minimum buffer of free collateral:

The bank should internally set a buffer of free collateral that should safeguard the institution against unexpected additional
collateral demand and unexpected shortfalls of collateral supply.
The expected unencumbered volume should never fall short of the buffer.
(D) Discussion: Minimum collateral buffer and/ or LCR-buffer ?

The LCR-buffer already caters for additional collateral posting for margin calls and collateral devaluation. It also should cater
against „any other expected outflow“. Hence, if a bank follows this „going concern“ view of the LCR (with new/ expected
business included) and the bank believes in the LCR-calibration of collateral postings and repo rollovers, the collateral buffer
can be set to zero because the LCR-buffer (= a collateral user) insures the bank against it.
INSTITUTE 70
Objective: ensure sufficient unencumbered collateral at every point in time
Unenc t +1 = Coll t +1 - Enc t +1

= Coll t + DColl t +1 - [ Enc t + DEnc t +1 ]
Expected evolution
Expected evolution [-Maturing existing supply deals

of collateral buffer + new supply deals]
Collateral0
(supply) Unenc0 [-Maturing existing demand deals
(Excess + new demand deals]
supply)
time
(C) The drivers behind the evolution of the key figures are:
1. Evolution of collateral buffer:
Maturing supply deals reduce, new/ rolled over supply deals extend the collateral buffer.
2. Evolution of encumbrance rate:
New demand deals increase, maturing demand deals reduce the encumbrance volume/ rate.
INSTITUTE 71
Expected evolution
Expected evolution [-Maturing existing supply deals

of collateral buffer + new supply deals]
Collateral0
(supply) Unenc0 [-Maturing existing demand deals
(Excess + new demand deals]
supply)
time
Δ Provided/ used
today t+1 t+2 t+3 t+4 t+5 ...
collateral
... Repo, €-leg
Reduce available
Mat. -20 -10 -7 -25 -15 -40 ...
collateral
Collateral increase available
Supply New +20 +5 +2 +20 +10 +35 ... collateral
... ... ... ... ... ... ... ...
... ... ... ... ... ... ... ...
Reduce
Repo, Sec
Mat. -20 -10 -7 -25 -15 -40 ...

encumbrance
Collateral Increase
New +20 +5 +2 +20 +10 +35 ... encumbrance
Demand
... ... ... ... ... ... ... ...
...
... ... ... ... ... ... ... ...
INSTITUTE 72
The volume of maturing deals is fairly deterministic.

But: how to plan the volume of the new business?
Δ Provided/ used
today t+1 t+2 t+3 t+4 t+5 ...
collateral
... Repo, €-leg
Reduce available
Mat. -20 -10 -7 -25 -15 -40 ...
collateral
Collateral increase available
Supply New +20 +5 +2 +20 +10 +35 ... collateral
... ... ... ... ... ... ... ...
... ... ... ... ... ... ... ...
Reduce
Repo, Sec
Mat. -20 -10 -7 -25 -15 -40 ...

encumbrance
Collateral Increase
New +20 +5 +2 +20 +10 +35 ... encumbrance
Demand
... ... ... ... ... ... ... ...
...
... ... ... ... ... ... ... ...

=> Business planning process + business commitments + limits
(1) Business planning process:
- Each business line/ desk plans volume of product, type andf volume of collateral used/ provided
- The collateral manager has to make planned supply and demand converging or take actions to fill the gap.
(2) Business commitments:
- The business lines/ desks commit to planned (net 1) figures.
- Deviations are asymmetrically penalised:
- Shortfall supply and excess demand are not tolerated (=> limits).
- Excess supply and shortfall demand are penalised.
(3) Limits:
- A business line/ desk is allowed to use up to its planned collateral limit. It is also charged (static!) that the collateral is
blocked for its use.
- A business line/ desk is obliged to provide up to its planned collateral limit. It is also only (dynamically) rewarded for
the supplied collateral.
- The asymmetry between static charging and dynamic rewarding ensures optimal usage of limits.
1) Net comprises business lines that are both suppliers and demanders (e.g. a desk that performs repo and reverse repo). The business line
commits on a net supply (or net demand). Other business lines like trading might be to a large extent demanders (IM 0, VMt).
INSTITUTE 73
Expected evolution
Expected evolution
Collateral0
(supply) Unenc0
(Excess
supply)
time
We assume that the collateral manager wants to avoid that the non-encumbrance enters the buffer.
Which counteraction can the collateral manager take to avoid that?
Option 1:
- Increase the collateral pool and stick to planned encumbrance.
- Possible methods: borrow securities, buy collateral, repo non-collateral and changing it to cash (=collateral),
replace unsecured lending by reverse repos
Option 2:
- Keep collateral pool constant, but reduce encumbrance.
- This directly affects the business.
- Possible methods:
move trades to CCP to benefit from maximum netting and reducing margining, call lent securities, reduce trading, replace
Repo funding by Pfandbrief funding (Pfandbrief uses non-liquid assets for securities)
INSTITUTE 74
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 75
5. Capital requirements
Accounting
Product Capital and Margin requirements
representation
ì 8% × RW[Rating, Obligor class]; CRSA

Reverse Repo CR RRepo = EaD × í Vasicek Model
î Unexpected Loss [PD, LGD]; IRBA
Reverse EaDt = max[ N tloan - MtM tcollateral × (1 - HC ),0]

Repo CR Collateral = 0
Received VM t = max[ MtM tcollateral × (1 - HC ) - N tloan,0]
Collateral
IM 0 = 0
Cash Repo CR cash = 0

Collateral ìïCR Market Risk ; Trading book
CR = CR
Collateral
= í Credit Risk
without Repo
Repo ïîCR ; Banking book
VM t = max[ N tloan - MtM tcollateral × (1 - HC ),0]
IM 0 = 0
Collateral ì
ïCR
Market Risk
; Trading book
CR Collateral
= CR without Repo
= í Credit Risk
ï
îCR ; Banking book
Security
Lending
INSTITUTE 76
Derivative trading
(A) Capital requirements, without margining
+ 2. Counterparty migration
1. Counterparty default risk
risk
Approach
Unexpected loss per 1€ exposure x Exposure [in €] Δ Credit Value Adjustment
SA RW(RatingExternal)1 x 8% x
2.1
2.33 × ( )2 + ( )2
OTC CEM,
IMM SM, - CVAlosses +
K(PDInternal, R(PD)) x LGD x 2.2 ccMarket Risk-IRM(ΔCVA(Δs))
α*EEPE
2% x 8% x 0
CCP
Min[2%*Trade Exposurei + 1.25*Default Fundi;20%*Trade Exposurei]
INSTITUTE 77
Derivative trading
(B) Capital requirements, with margining
VM t = max[ - MtM tcollateral,0]

ì Net replacemen t cost
ï[0.4 + 0.6 × ] × Notional × wregulatory, Standardis ed M odel
OTC- IM 0 = í Gross replacemen t cost
derivative ïîPFE[99%,10d, StressedPeriod Asset class i ], Internal M odel + M in. Requireme nts
IM0paid capital
IM0rec
VM t = max[ - MtM tcollateral,0]

IM 0 = CCP - Initial MarginModel ESMA -Min Requirements
CCP-
derivative IM0paid capital
IM0rec
INSTITUTE 78
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 79
What could go wrong in collateral process:
A) Prior to default:
Risk Description Mitigation
• Manual End-to-end straight through
• Manual processes
processingprocesses
1. Operational risk • New products with new processes • Extensive testing of new processes
• Number of staff does not grow with business • Budget for infrastructure and human
volume ressources
• Collateral is not obtained • DvP1-systems, Tri-party: inhouse coll. transfer

2. Settlement risk • Many margin calls • CCP: 1 margin call only
• Value risk: hedgeable by CDS, but margin risk

• Downgrade of collateral
not hedgeable
• Wrong-way risk (value of collateral drops if

3. Market risk derivative drops (e.g. fixed-rate bond to • Use uncorelated bond (e.g. floating)
collateralize IR-swap)
• Large value drop because low diversified

• Diversify collateral pool across issuers
collateral pool
4. Insufficient • Unexpectedly high collateral demand

• LCR-HQLA-buffer
collateral meets with unexpectedly low collateral supply
5. Legal risk • Ensure legal title • Use standard master agreement
• Speak to and educate your counterparties hat

• Lack of transparency od default procedure, happens in case you default !!
5. Intransparency related risks, legal rights, responsibilities and • Counerparty that feel comfortable with the
processes collateral procedure and title are likely to
repo wwith you also in hard times
1) Delivery-vs.-Payment systems
INSTITUTE 80
B) At default/ in times of counterparty rumours:

Risk Description Mitigation
• Haircuts increase and collateral devalues in
• Use (internally) more conservative haircuts
times of increased countereparty doubts
1. Procyclicality
of haircuts
• Haircut increase just when collateral is
• Extensive testing of new processes
devalued
2. Procyclicality • No roll-overs of secured funding in times of

• LCR-HQLA-buffer
of re-use stress
• Collateral not liquifiable (or only at high

3. Market discounts) because many others want to do
the same (=> contagion to counterparties with • Use ECB-eligible collateral
liquidity risk common exposures, not necessarily directly
interconnected),
• transfer and sale process: brokerage

agreements, draft and sign contracts,
4. Intransparency • Be operational ready to liquidate collateral
internally assign responsibilities to people
involved in liquidation
INSTITUTE 81
Systemic: Repo run
Critics
Gorton & Meverick (2012)
(Richard Comotto, 2012)
• Repo uses only structured credit (ABS, • Europe:
RMBS, CMBS, CLO, CDO, ...) as collateral, Govt collateral: 80%
• GovtBonds are not used as collateral Structured credit collateral: only
1. Assumption: in Tri-party (10%), and only 3.2% of
Tri-party
=> 0.3%
2. Stylized fact: Haircuts increased substantially Tri-Party haircuts have been stable
3. Evaporation ignored dried up
of unsecured
market:
- haircuts increased - quick estimation for the changed
=> successive withdrawal haircut, but applied to European
(would be HC=100%: maximum haircut !!) volumes => -3%
=> secured funding evaporated
=> banks need to deleverage
4. Argument: => asset fire sales
=> Reduce collateral value more
=> deleverage further
INSTITUTE 82
C1) Have haircuts been volatile during the crisis?: Yes, but ...
C2) ... the categories with large haircut changes only account for 14% of
total collateral pool => overall collateral value only drops by -2.7%
Source: Haircuts and initial margins in the repo market, 2012, European Repo Council, p.11
INSTITUTE 83
D) Pre- and post-crisis haircut arrangements:
Since the crisis, many market users are reported to

have adopted the haircuts/initial
margins set by Basel II (standard supervisory haircuts),
central banks or central counterparties (CCPs)
as benchmarks.
Source: Haircuts and initial margins in the repo market, 2012, European Repo Council, p.11
INSTITUTE 84
Source: FSB, Securities Lending and Repos: Market Overview and Financial Stability Issues, 2012, p16
INSTITUTE 85
- Reduction of credit risk if -Client requirements/ preferences not

pledged collateral, but increase adequately captured in collateral system
of Op- and Market Risk => likely to cause future disputes
- Missing signatures/ agreements
0.
Collation
- Eligibility matrix outdated

- Reduction of credit - Haircuts outdated
6. 1.
risk, but increase of - Ratings not updated
Mitigation Allocation
Op- and Market Risk
- identify collateral - Delayed collateral

deviations 5. 2. confirmations
=> collateral disputes Reconciliation Calculation - Wrong data feed
- Model not updated
- Quantity over quality - Limited pricing competence

- No global, centralised report 4. 3. - Spreadsheet pricing
- Lack of staff Reporting Evaluation - Valuation errors and different models
- Encumbered assets not all flagged
INSTITUTE 86
Agenda
1. Introduction
2. Overview
3. Operating Model
7. Conclusion
8. Appendix
INSTITUTE 87
Conclusion
1. Overview:
Collateral are assets, usually highly liquid and with low credit risk.
They are used for secured funding, security lending/ borrowing, liquidity buffers and margining
for derivative trading as well as payment/ settlement systems.
2. Operating Model
Collateral management was historically a product-specific back office function.
Due to the tremendous demand and the necessity to generate revenues on the collateral pool,
CM becomes centralised, cross-product unified, data-harmonised and a profit (or a cost) centre.
The transfer pricing makes the cost of collateral transparent and incentivises the (re-)use
of collateral.
Collateral planning ensures that businesses can count with sufficient collateral. For this,
they plan their collateral demand and supply. A collateral buffer for unexpectedly high
collateral demand and unexpectedly low collateral supply is not necessary if the
LCR/ liquidity buffer carefully takes the planned figures into account.
Capital requirements for CCP-trading is 2% risk weight for the exposure and for the
default funds. Capital requirements for OTC-derivaitves also include CVA.
The major risk is the non-readyness of an organisation to liquidate collateral in case of a default.
This should be legally prepared and operationally trained upfront.
Appendix
INSTITUTE 88
Questions?

Aarhus University,
Email:
chsch@asb.dk
INSTITUTE 89

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26th September 2013, Frankfurt

1. Introduction 09:00 – 10:30

Jörg Lindenberg/ Jan Eisenhardt, TXS GmbH

G-SIB Global - Systemically Important Banks

SIV Special Investment Vehicle

Dr. Christian Schmaltz

You You You You You You You

You 3. Seminar interest You

(own collateral) or outside of the balance CB

Large custodians: 1. BYN Mellon, 2. JP Morgan Chase, 3. State Street, 4. Citigroup

Further reading: http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp68.pdf

Margining Funding R. Payt/ Lending

Margining Funding R. Payt/ Lending

Margining Funding R. Payt/ Lending

Margining Funding R. Payt/ Lending

Margining Funding R. Payt/ Lending

More (+) Collateral supply

Direct 1. Govt + Government bonds

+ Collateral optimisation + mobilised collateral

+ Collateral re-use and transformation

Central Bank Repo\ CCP

ICE Clearing Europe

ECB Ext Basket

Haircuts (= initial margin)

1. Haircuts is a proxy for how different to asset

Re-employability is crucial to leverage collateral supply.

Ownership Re-employability CCP1 OTC2

Is transfered to the No additional agreement

Collateral No: Yes:

Re-employability is crucial to leverage collateral supply.

• Free rehypothecation of VMt

Source: Department of the Treasury, US, July 2013

Source: Department of the Treasury, US, July 2013

Positioning Collateral accountant Collateral manager Collateral optimizer

Philosophy Supporter Enabler Driver

Mainly manual Electronic, but flow breaks End-to-end

Objectives of collateral management:

1. Ensure required collateral from margining, LCR, MaRisk and PfandbriefG.

=> To align the objective of extra revenues and additional liquidity

• Which collateral is acceptable?

2. Collateral calculation: how much collateral is

b) Allocates (or proposes) collateral that could be

5. Reconciliation: has collateral actually be

0. Can be inhouse or outsourced (e.g.

B) Register Entering the collateral space

1. Allocation: product-specific specialists

E.1) Block collateral E.2) Transfer collateral Book initial proceeds

To use IMM for CVA Repo SecDeals Trading

Agree on collateral type, CCP- CCP- With Ly With cover

amount and re-use rules rules Mgt pool mgt

Receive collateral IM0+

From Ly From cover

Liquidate received collateral

To use IMM for CVA

Daily collateral management tasks

• Update haircut and • Monitor collateral • Settle manufactured • Internal:

C) Collateral inventory management

D) Reporting (collateral cockpit)

1. Controlling data integrity to calculate margins

1. Track re-use of posted collateral

Concentration 1. Track collateral concentration

1. Type and volume of collateral received and posted