Where cash is provided as the collateral, there are two mechanisms for its transfer:
1) Delivery/Receipt Versus Payment (DVP or RVP) where the settlement of securities is instantaneous with the settlement of the cash.
2) Free Of Payment (FOP) also know as Delivery/Receipt Versus Payment (DVF/RVF) where the securities and cash are transferred reliant on the other being received. I.e., On a new loan, cash is delivered then securities released. On a closing loan, securities are return then cash is released.
Free of Payment (FOP) is the most common mechanism in EMEA markets, mostly in relation to equity markets.
In all cases, a rebate is provided by lender/cash receiver to borrower/cash provider based on a negotiated rate expressed a Basis Point – Benchmark. (See rebate calculation is the section [Accrued Income Calculation Method|https://www.islaemea.org/isla-best-practice-handbook/subsection/IBP-157/)
(IBP-318 UNDER ISLA REVIEW)
Similar to a non-cash collateral mechanism, a cash pool is a single unlinked pool of cash between two parties to collateralise multiple stock loans.
It is recommended that the unlinked Cash Pool is used to collateralise multiple free of payment loans. The underlying loans should be flagged and identified as being versus Cash Pool so that the value of those loans, plus any margin, can be compared to the value of the Cash Pool. Any delta amounts should be moved daily, prior to cash cut-off, to clear any potential exposure.
Where multiple Cash Pool currencies are required, the underlying loan(s) should be booked with the same billing loan currency as the collateralising pool, and the value of each pool should be matched versus the value of those trades.
Cross currency exposure should be avoided or at least cleared the next business day if the cash cut-off time has been passed. (IBP-319 UNDER ISLA REVIEW)
Standard Cash Pool
A pooling of outstanding loan value resulting in a single collateral agreement and margin movement.
This approach is favoured by many firms for its process simplicity. (IBP-322 UNDER ISLA REVIEW)
EU Cash Pool
Each loan is collateralised on individual basis, with all loan being marked-to-market daily, the net of those movements resulting in the collateral movement.
As this requires more processing, it is considered by many firms as non-standard.
(IBP-323 UNDER ISLA REVIEW)
Collateral, in the form of assets, is delivered by the borrower directly to the lender's account. The market value of the collateral is typically higher than the market valuation of the lent assets.
When collateral is received under this type of arrangement, the received collateral may be pooled or managed in a segregated/separate account structure.
This type of activity may also be related to financing trades and/or be part of a negotiation where specific securities are provided as collateral versus the borrowed securities.
NOTE: The collateral taker may re-use the collateral (Rehypothecation) for other activities. Where the counterparts are governed by SFTR, there should be an exchange of documentation noting the re-use of collateral (See SFTR Article 15
(IBP-324 UNDER ISLA REVIEW)
Non-Cash Triparty Agent
Collateral, in the form of assets, is delivered by the borrower to a third party under a collateral arrangement with the lender.
Borrower and lender agree a daily collateralisation value which is then passed to a triparty agent. The triparty will then transfer the necessary asset into the lenders (collateral takers) collateral account at the triparty agent. Both parties are then advised of the successful transfer through an agreed mechanism/function.
(IBP-325 UNDER ISLA REVIEW)
Some counterparts lend without taking collateral, typcially where a simultaneous borrow occurs with the same counterpart effectively nets exposure.
As this activity is not within the scope of the standard master agreement, it is a not a recommended practice.
(IBP-326 UNDER ISLA REVIEW)
Central Counterpart (CCP)
TBC (IBP-327 UNDER ISLA REVIEW)
The calculation of exposure should follow the below formula:
If Collateral Type = Cash then
Loan Value = ((LoanQuantity * SecurityPrice)*Margin%) * FXRate)
If Collateral Type = Non-Cash then
Exposure = Loan Value – ((CollateralQuantity*SecurityPrice)*Haircut%* FXRate)
(a) Margin% may be dependent on factors such as asset class, credit rating, liquidity, loan ccy vs cash collateral currency. Margin% must be bilateral agreed.
(b) Margin% is not usually applied to non-cash collateralised transactions. However, it may be used in cases where Tri-Party agent applies Haircut% to collateral and cannot know factors such as cross currency exposure between loan & collateral
(c) FXRate should be previous close-of-business see Asset Price
(d) Please note the formula for billing IBP-157
A portfolio should be provided in the case of a margin call discrepancy and should include all the below details:
- Quantity of security
- Dirty Price of security
- Security ID
- Trade price
- FX rate
- Loan or collateral indicator
- Accrued rebate
- Exposure including Haircut/Margin A margin call should be issued in the currency (or one of the currencies) set out in the initial agreement. Each counterparty should have the ability to agree a margin call via a Triparty agent or bilaterally, depending on the counterparty's agreed preference. Contract Compare systems should be used to ensure exposure, price, quantity and margins are in line. (IBP-166 UNDER ISLA REVIEW)
There is also the possibility of margins being re-agreed or altered in the below scenarios: i) In the event of large fluctuations in the market, due to broker default or market uncertainty, margins may be increased to protect the client from large market swings resulting in exposure. ii) If a piece of collateral is pledged which has a stale price, it is common for the margin to be increased incrementally until an updated price is received. If a security is unpriced for an agreed period of time, the security is deemed ineligible. (IBP-164 UNDER ISLA REVIEW)
In line with Basel III, each entity must ensure there are sufficient resources allocated to collateral management to ensure there is an efficient margin call agreement and collateral settlement process. All collateral processes and margining logic should be reviewed internally on an annual basis to ensure the current policy is reflective of the current market environment. In the event of a collateral margin call dispute, both counterparties should have a contingency plan documented and agreed common source of information (i.e. price or FX source) to allow the margin call to be agreed. In the event that a counterparty is not sufficiently completing the above, resulting in delayed margin call agreement or even resulting in under-collateralisation, the counterparty may be penalised. I.e. increased pricing, increased margining or cease trading. (IBP-165 UNDER ISLA REVIEW)
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