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Collateral

ISDA, Margin Surveys, here. Global collateral is up to $3.7B. Doubled since the Credit Crisis. Survey data goes back about 13 years.

The ISDA Margin Survey is conducted annually to examine the state of collateral use and management among derivatives dealers and end-users.

John Hull, The FVA Debate, here. 2013 presentation at NYU. Hull and White say you are gonna get arbed if you force blended funding rate charges into individual OTC contract valuations.

Papers by Hull and White Related to FVA

“The FVA Debate” Risk 25th anniversary issue, July 2012. “The FVA Debate continued” Risk, Oct 2012.

“LIBOR vs. OIS: The Derivatives Discounting Dilemma” Journal of Investment Management, 11,3 14-27

“Collateral vs. Credir Issues in Derivatives Pricing” Working Paper

“Should a Derivatives Dealer Make a Funding Value Adjustment” Working Paper

Valuing Derivatives: Funding Value Adjustment and Fair Value”

Albanese and Iabichino, The FVA-DVA Puzzle: Risk Management and Collateral Trading Strategies, here.

Abstract. In the aftermath of the crisis, valuations of fixed income derivatives have signifi- cantly diverged from the principles of arbitrage-free pricing and the law of one price. Discrep- ancies arise because of the incompleteness of collateral trading markets which lack of reverse REPO contracts accepting OTC derivative receivables as collateral. This circumstance forces banks to implement sub-optimal funding strategies by borrowing unsecured and passing on their own credit spread to clients.

In this paper, we propose that excess collateral on OTC books should be considered as an unstable source of funding, not fungible with bank debt. As a consequence, we define the FVA as a book level, non-transactional amount computed assuming that the rate for riskless lending is OIS as opposed to being the funding rate. With this definition, the FVA does not overlap with the DVA.

We discuss analytics and strategies to manage FVA risk jointly with CVA, DVA and default loss risk. We also discuss market-completing collateral trading strategies to take advantage of the FVA-DVA funding arbitrage.

Mahesh Muthu, Wall Street & Technology, Focus on Collateral: Optimizing ISDA CSA Document Metadata, here. This is Anjan’s company.

In the OTC derivatives market, collateral management terms and conditions are largely driven by the framework within the ISDA Credit Support Annex (CSA) document. ISDA CSAs can be heavily negotiated documents, but at a minimum contain terms covering eligible collateral, how collateral can be held and used, as well as terms covering margin calculation and posting. Although the information embedded within these documents seemed of little importance prior to the 2008 financial crisis, many institutions are now investing heavily in people, processes, and technology to mine and actively manage such document metadata.

Throughout the last several years, financial institutions have come to realize the information should be used not only to govern the operational components of collateral management, but that it also plays an important role in trade pricing, collateral optimization and liquidity management.

For example, with respect to trade pricing, cash-collateralized trades should be priced based on the overnight indexed swap (OIS) rate, or most inexpensive to deliver collateral within the eligible collateral schedule in the CSA. A larger list of eligible collateral and currencies in the CSA represents a valuable “switch option” to whichever party is posting collateral. Clients with asymmetrical CSAs, in which only one party must post collateral, or CSAs limited to certain legal entities or products, may turn out to be too expensive to service because of newly introduced capital charges under Basel III. Many firms have established a credit value adjustment (CVA) trading desks to ensure counterparty credit risk is appropriately measured, hedged and priced into across the board trading activity, which requires CSA static data as a key input.

Additionally, the data from the CSA greatly facilitates collateral optimization. Using the static data relating to eligible collateral, haircuts, rehypothecation, etc., along with margin call and asset inventory information, firms can optimize their collateral and reduce funding costs. However, in order for institutions to make informed decisions across these functional areas, they require a well-planned controlled operation to mine information from CSAs.

Numerix, A Primer on Funding Value Adjustment (FVA): Numerix Video Blog, here. Video from Sep 2012 isn’ t bad.

In this video blog, we will delve into this issue with Numerix Host James Jockle, SVP of Marketing, and Denny Yu, Product Manager Risk of Client Solutions, discussing the debate over FVA, including proposed methodologies, the notion of collateralized versus uncollateralized trades and OIS valuation challenges in the presence of CSA thresholds.

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