Collateral Management

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

This chapter describes the process of novation, whereby one party removes itself from an existing trade whilst a third party takes their place. Should this post-trade execution event occur to a particular OTC derivative trade or position, there will be a fundamental impact to the ongoing collateral management of that 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:

FIGURE 38.1 Pre-novation parties

FIGURE 38.2 Post-novation parties

Following novation:

• Party ...