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Collateral Management by Michael Simmons

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CHAPTER 38OTC Derivatives and Collateral – The Collateral Lifecycle – Throughout Lifetime of Trade – Post-Trade Execution Events – Novation

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 Throughout Lifetime of Trade.

38.1 INTRODUCTION

Where a firm has a live and current OTC derivative trade (or position) with a particular counterparty, at any point during its lifetime that trade or position may be subject to novation.

Novation is a generic term meaning the legal act of replacing one participating member of a contract with another. The term is used in various situations involving the change of parties to a legal contract, and not just for OTC derivative trades.

Novation arises where one of the parties to a trade chooses to exit that trade, by introduction of a third party in its place. This situation is represented in Figures 38.1 and 38.2, the first of which represents the original parties to the trade, prior to novation:

The figure shows the pre-novation parties. The bidirectional arrows are connected with Part A (on the left-hand side) and Party B (on the right-hand side).

FIGURE 38.1 Pre-novation parties

FIGURE 38.2 Post-novation parties

Following novation:

  • Party ...

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