7Collateral – Enforceability, Reform and Optimisation
This chapter seeks to focus on collateral (also known as margin), which acts as a credit risk mitigant (following from Chapter 6, it can also be critical in reducing the regulatory capital requirement for prudentially regulated institutions). We briefly detail the considerable regulation that has imposed (and will continue to, in the short‐term future) significant new mandatory requirements on market participants in terms of their margining practices. We will of course draw out the legal data perspective as we journey through these items.
What is Collateral?
Collateral flows lie at the heart of any proper understanding of market liquidity, and hence of financial stability. The financial plumbing encompasses the biggest pipes that form the nexus between collateral and money; it can be seen as the interaction between nonbanks and banks in money markets and capital markets (the latter of which include securities lending, repos, derivatives, and prime brokerage). These activities are the nuts and bolts of financial plumbing. (Singh 2017)
Collateral is a credit risk‐reduction tool, which has been used for many centuries to provide security against a trade counterparty defaulting. Like close‐out netting, it mitigates risk by reducing credit exposure. Its effect is to substitute the credit risk of the issuer of the collateral provided, for that of the counterparty to the transaction (on whom one is seeking to reduce credit ...