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Collateral Management by Michael Simmons

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CHAPTER 30OTC Derivatives and Collateral – The Collateral Lifecycle – Post-Trading – Trade/Portfolio Netting

The figure shows the OTC derivative collateral lifecycle. It consists of a series of logical and sequential steps which should be experienced in order for a firm to process repo trades in a safe and secure fashion. The steps are as follows:
Step 1: Pre-Trading.
Step 2: Trading.
Step 3: Post-Trading.
Step 4: Throughout Lifetime of Trade. 
Step 5: Trade Termination.
This stage of diagram depicts the Post-Trading.

Following formal agreement of the trade details with the counterparty, it is generally accepted as beneficial to both parties if a trade can be netted with another trade or with an existing position. Such netting is applicable to both buy-side and sell-side firms.

30.1 INTRODUCTION

Trade/Portfolio netting is the process of offsetting trades that contain the same details as an existing position in the same OTC derivative product and updating that existing position to a new net position, whilst terminating (cancelling) the original trades. This netting process is commonly known as portfolio compression.

The holding of OTC derivative trades to their scheduled maturity date, especially when trades have a lifetime of up to 50 years, carries significant annual maintenance costs and risks, which can be ...

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