5.2 Collateral Terms

5.2.1 Valuation Agent

The valuation agent is normally the party calling for delivery or return of collateral and thus must handle all calculations. Large counterparties trading with smaller counterparties may insist on being valuation agents for all purposes. In such a case, the “smaller” counterparty is not obligated to return or post collateral if they do not receive the expected notification, whilst the valuation agent is under obligation to make returns where relevant. Alternatively, both counterparties may be the valuation agent and each will call for collateral when they have an exposure.

The role of the valuation agent in a collateral calculation is as follows:

  • To calculate credit exposure under the impact of netting.
  • To calculate the market value of collateral previously posted.
  • To calculate the uncollateralised exposure.
  • To calculate the delivery or return amount (the amount of collateral to be posted by either counterparty). This is likely to differ from the uncollateralised exposure due to the discrete nature of collateral agreements, which means that collateral is transferred in blocks. This is covered in more detail in Section 8.5.1.

Third-party valuation agents provide operational efficiencies, and can also help prevent disputes that are common in bilateral collateral relationships.

5.2.2 Types of Collateral

Cash is the major form of collateral taken against OTC derivatives exposures (Figure 5.4). The ability to post other forms of collateral ...

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