Collateral has been the most effective credit risk mitigating technique, not only in the derivatives but in many markets, but its success is predicated on being enforceable at the critical moment ie when your counterparty defaults.
The derivatives market through the ISDA Credit Support documentation , has developed two approached so to collateral:
- Security Interest — most typically expressed in the NY law governed CSA and the more traditional approach.
- Outright Transfer — (English Law CSA) which relies on close out netting to be enforceable.
In either scenario, there are enforceability issues to assess to ensure that you can rely on collateral posted when you need to.
For the security interest, for example you would need to assess the adequacy of the quantum of collateral and that will rely on whether netting is enforceable in the jurisdiction of the counterparty.
For the outright transfer to be effective, again closeout netting needs to be enforceable.
D2LT works with its clients to ensure that they have an effective process to secure adequate opinions and to ensure that they are reviewed effectively and recorded.
This operating framework should be aligned to the close out netting analysis but is often separate. We often help clients to enhance this operating model.