Collateral Management Collateralization in the Trading Business

In financial trades, collateral management has the purpose of reducing the risk of OTC derivatives, repo and security lending transactions by depositing cash or security collaterals. Collateral management Depending on the development of the underlying asset – e.g. in the case of an OTC derivative – collat- comprises various forms of erals are exchanged between both counterparties, which occur as open risk positions within the margin collateralization of financial process. Open margin positions need to be settled in order to reduce the loss at default. As a result of the transactions – in the traditional financial crisis, mitigating counterparty risk or the default of contractual obligations – has gained credit business as well as in the trading business. In recent years increasing importance. collateral management within the trading business has become a Major Market Drivers topic of increasing importance – not only for financial institutions The increasing attention towards collateral management is characterized by the following market with high trading frequencies of drivers: over-the-counter (OTC) derivatives • Operational challenges emerging due to changing market practices and volume growth and repo and securities lending • Regulatory influences (i.e. Basel III, EMIR) transactions, but also for investment firms, asset managers, • Development of strategic collateral management approach and insurance companies. Operational Challenges The estimated volume of collateral in the OTC derivatives markets has increased steadily in recent years. During the last 14 years, the average annual growth rate of the estimated Collateral Volume amounted to 23 %. Collateral agreements within OTC derivatives arrangements appears to have become the norm today. Collateral management agreements prescribe requirements to daily margining and are being expanded to include further asset classes such as FX. Regulatory Impacts Recent regulatory initiatives are impacting collateral management: • New Basel III capital adequacy requirements • Clearing standardized OTC derivatives transactions through Central Counterparties (CCPs) • Mandatory collateralization of bilateral derivative contracts Basel III Basel III modifies the structure of minimum capital requirements: The supplementary capital has been reduced whereas the core equity capital has been increased to 4.5 %. Under Basel III, collateral assets can be part of the regulatory capital, which leads, in contrast to Basel II, to a leveraged discharge.1 Central Counterparties The clearing and settlement of OTC derivatives transactions through central counterparties (CCP) reduces the systemic risk in collateral management. However, it increases the total amount of collateral required. The reduction to one or several central counterparties employed by a market participant consolidates the margins and required collaterals for that participant. However, the scope of accepted collateral is expected to narrow, wheras the quality of the collateral required by CCPs is significantly higher.

1 See CRD IV Netting Flag Securities FO Systems Legal Database Market Data Static Data Collateral Strategy Collateral Flag Inventory

Trade Data Available Assets Counterparts Contract Data e.g. FX Rates, Ratings, … Collateralised Collateralised Market values (Collateral Pool) Securities Products Counterparts Collateral Management -System Our Offering Trade Data Collateral Valuation Margining Workﬂow Reconciliation Collateral Monitoring Collateral Allocation Consolidation Bank-wide Agreement Collateral Pool Interest Calculation Collateral Settlement Dispute Management Reporting Legal Framework Collateral Process Guidelines Management Management Policy BearingPoint supports its clients, Collateral Cash Collateral Securities Collateral Settlement Collateral Positions Communication Transactions Transactions Status IT Policy as a trusted advisor, in the Collateral Regulatory Fax / Mail / BearingPoint Responsibilities development of the conceptual FO/BO/ Accounting Systems Limit System Eligibility Criteria Reporting XML Collateral design (strategy, policies, road Management Credit Business Capital Markets Business  Credit Trading Exchanges map) and in operational solutions Customers … Collateral Process Approach Customers Counterparts l a g

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L (process and IT optimization). Contract Management Margin Management Processes Organization Back O ce Credit Operations BearingPoint’s collateral Limit Cash Management Valuation Management Credit Risk Controlling management approach takes into Risk Control

Collateral Re-Use Reconciliation Finance Accounting/Regulatory Reporting account all relevant aspects and can be tailored to clients’ needs. Collateral Monitoring Dispute Management Technology IT

Bilateral trading relationships will continue to exist, particularly for non-standardized derivatives not cleared by CCPs. Strategic Collateral Management Collateral management is evolving as a central element with strategic importance. Active management of the scarce commodity “collateral” can result in positive effects in respect of the dependent variables risk, return and liquidity. This process requires the creation of transparency of available collaterals (collateral pool) and the best possible allocation of collateral assets as well as a more precise attribution of collateral costs to trading products and/or business units. Margin Requirements for bilateral derivatives The European Market Infrastructure Regulation (EMIR) lays out collateral requirements for non-standardized derivatives not clearable via CCPs. Affected market participants will have to exchange both initial and variation margin in accordance to corresponding counterparty risk. The currently high number of unsecured bilateral derivative contracts (approx. 30 %) will therefore be reduced significantly. The introduction of margin requirements follows a phase-in model, becoming effective on December 1, 2015 for the most significant market participants. Smaller market participants with a derivative contracts volume of less than 8 Billion EUR (outstanding gross nominal value) will be required to exchange collateral as of December 1, 2019. Outlook Market participants need to re-route their collateral management processes while correspondingly facing growing operational challenges and a changing regulatory environment. Especially market participants, whose collateral management practices consist of heterogeneous, customized solutions and who lack a collateral management strategy, should undertake immediate action. The recent developments within the collateral management landscape require a complete analysis of the existing collteral management processes and a roadmap for change. Contact

Dr. Robert Bosch Partner About BearingPoint [email protected] BearingPoint consultants understand that the world of business changes constantly and that the resulting complexities demand intelligent and adaptive solutions. Our clients, whether in commercial or financial industries or in government, experience real results when they work with us. We combine industry, operational and technology skills with relevant proprietary and other assets in order to tailor solutions for each client’s individual challenges. This adaptive approach is at the heart of our culture and has led to long-standing relationships with many of the world’s leading companies and organizations. Our 3500 people, together with our global consulting network serve clients in more than 70 countries and engage with them for measurable results and long-lasting success. www.bearingpoint.com