Recent media articles in two of our favorite publications (The New York Times, The Wall Street Journal) raise interesting points about an important derivatives risk management practice: collateralization of exposures. Both stories essentially question whether net derivatives exposure accurately captures the risks of a firm’s derivatives activity. They say that net exposure assumes (among other things) that collateral management is rigorous, and they wonder whether it really is.
Fair questions. But we wish the stories had gone one step further and sought answers to them by examining the data and the initiatives that exist or are underway in this area.
According to ISDA’s Margin Survey, 73% of OTC derivatives exposures are collateralized. The chart below shows that collateralization is highest for hedge fund exposures and lowest for governments and supranationals.
What do firms post as collateral? Cash represents around 81% of collateral received in 2010. Government securities constitute 10% percent and the rest is comprised mostly of corporate bonds, equities and government agency securities.
Looked at by product type, 93% of all credit derivatives trades executed by firms responding to the survey were subject to collateral arrangements during 2010. 70% of all OTC derivatives transactions were subject to collateral agreements during this period. This includes transactions with end-users and spot FX transactions, which due to the nature of these trade types, are not generally collateralized.
The 14 largest reporting firms, representing the world’s largest derivatives dealers, reported higher rates of collateralization. For this group, an average 96% of credit derivatives trades were subject to collateral arrangements during 2010. Overall, 80% of all OTC derivatives transaction executed by the large derivatives dealers were subject to collateral agreements.
The data confirm that collateralization is an important component in managing the derivatives exposures of market participants worldwide. That’s why ISDA and our members are engaged in a broad set of collateral-related initiatives — including research, documentation, best practices and practitioner guidelines.
We also believe it’s important for policymakers to have an accurate understanding of collateralization. That’s one reason why ISDA has called for the development of a single, global Counterparty Exposure Repository. This repository would provide an aggregated risk view for regulators of the net mark-to-market exposure for each counterparty portfolio, the corresponding collateral and the firms’ calculation of net exposure after the application of collateral.