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Collateral Optimization : Liquidity & Funding Value Adjustments, - Best Practices -

Author

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  • Genest, Benoit
  • Rego, David
  • Freon, Helene

Abstract

The purpose of this paper is to understand how the current financial landscape shaped by the crises and new regulations impacts Investment Banking’s business model. We will focus on quantitative implications, i.e. valuation, modeling and pricing issues, as well as qualitative implications, i.e. best practices to manage quantitative aspects and handle these functions to the current Investment Banking organization. We considered two pillars to shape our vision of collateral optimization: 1. Collateral as a refinancing instrument. Collateral is shifting from a mere hedging instrument for counterparty risk to a strategic refinancing instrument. 2. Improve asymmetric collateral quality and profitability. Recent requirements on collateralization highly impact collateral management through the increase in haircuts and funding of good-quality collateral. As a result, more and more banks are considering their net collateral balance as a KPI, i.e. monitoring their net collateral balance position and identifying the need in cash funding or transforming. We built our approach on three key standards: • In most cases, banks should prioritize the reception of cash and delivery of securities, what we call “Asymmetric Collateral Management”. - This implies banks have to capitalize on their valuation functions to boost profitability of the net collateral balance and take advantage of pricing conditions (e.g. for CSA Discounting, precise valuation and pricing of LVA/FVA). • Regarding Management of Non-Cash Collateral, banks should focus on - Optimization of the cash-circuit to manage the various levers of Non-Cash Collateral Transformation into Cash (repo market, central bank loans, re-hypothecation of received non-cash collateral as collateral for other deals). - Management of the collateral quality (both received and delivered), to source and receive high quality collateral and deliver lower quality collateral (Cheapest-To-Deliver Collateral Management). • Considering Management of Liquidity Issues, banks should carefully consider Collateral Management in case of liquidity issues (e.g. sale in case of default, use of re-hypothecation). Being unable to deliver good quality collateral can be seen as a negative sign for the counterparty’s financial health. We will further study the Collateral Offer Services of top financial institutions, providing specific expertise and a tailor-made approach to the new challenges of Collateral Management.

Suggested Citation

  • Genest, Benoit & Rego, David & Freon, Helene, 2013. "Collateral Optimization : Liquidity & Funding Value Adjustments, - Best Practices -," MPRA Paper 62908, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:62908
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    File URL: https://mpra.ub.uni-muenchen.de/62908/1/MPRA_paper_62908.pdf
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    References listed on IDEAS

    as
    1. Damiano Brigo & Agostino Capponi & Andrea Pallavicini & Vasileios Papatheodorou, 2011. "Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting," Papers 1101.3926, arXiv.org.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Collateral Management; Collateral Optimization; Collateral Transformation; Liquidity; Funding; Refinancing; Cheapest-to-deliver collateral; Credit Value Adjustment; Debit Value Adjustment; Liquidity Value Adjustment; Funding Value Adjustment; CSA Discounting; OIS Discounting; Collateral Arbitrage;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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