Collateral Management

CHAPTER 40OTC Derivatives and Collateral – The Collateral Lifecycle – Throughout Lifetime of Trade – Post-Trade Execution Events – Offset

This chapter describes the process of offsetting a trade, whereby an existing OTC derivative position (with a particular counterparty) is reduced to a zero position via the execution of an opposing trade with a different counterparty. Should this post-trade execution event occur to a particular OTC derivative trade, there will be a fundamental impact on the ongoing collateral management of that trade.

40.1 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 an offset.

Offsets arise where one of the parties to a trade chooses to exit that trade. The specific characteristic of this method of exiting a contract, from a particular firm’s perspective, is that it is the execution of an opposing trade to the existing trade, carried out with a different counterparty (to the original trade), the effect being to close overall exposure due to a zero overall position; however, exposure remains with both the original counterparty and the new counterparty. This situation is depicted in Figure 40.1, which shows both the pre-offset and post-offset situation:

FIGURE 40.1 Pre-offset and post-offset situation