To combat the risks of a loan return not being made or being delayed, the borrower will be re-quired to deliver collateral to the lender, usually with a market value which exceeds the loaned securities by a margin, typically between 5% and 15%.

The margin allows for any variation in the value of the outstanding loan. The securities are ‘marked to market’ - ie, priced at current market value on a daily basis, with any collateral shortfall made good by the borrower.

Whatever form the collateral takes - cash, securities or letters of credit - there are risks attached and in recent years, the management and monitoring of this collateral risk is a growing business.

Catching on fast, most notably in the ‘repo’ area (where a holder of securities sells them but agrees to buy them back at a later date at a set price) is the introduction be-tween the lender and the borrower of a third party which monitors the collateral during the period of the deal. In a European context, ‘tri-party repo’, as it is termed, is the province of the two main international central securities depositaries (ICSDs) -Euroclear and Cedel - and the US banks, Bank of New York and Chase Manhattan. Its popularity can be gauged by the experience of Euroclear. According to Van Hassel, tri-party repo has gone from zero to $30bn outstanding in just three years.

Tri-party repo is now a core bus-iness for us,” he says. “We aren’t a party to the deal as such, but act as a middleman in the course of the settlement process. We compare exposure and collateral on a daily basis. The tri-party route doesn’t shift the risk - this stays the same between the two parties - it’s the convenience and the flexibility thatpeople like.”

The collateral risk gets negated to an extent, says John Gilchrist of Cedel in Luxembourg, in that “we have a fairly sound knowledge and understanding of collateral and its value and that information can be provided to the two counterparties”. Gilchrist points to Cedel’s re-cently launched Global Credit Support Service as an example of how it manages collateral. Used in the swaps and derivatives area, the service allows counterparties to use any of the 100,000-plus sec-urities held by Cedel as collateral and monitors them in real time.

Bank of New York bills itself as the world leader in tri-party repo, having seen volume grow from less than $20bn a day in 1985 to more than $140bn. Chip Davy, product manager for global clearing and collateral management products says the big plus of the tri-party approach is that while the risk between the two counterparties remains with them, collateral monitoring “effectively limits the risk to the non-defaulting counterparty to one-day’s market movement. Broker dealers have been very successful in marketing repo in Europe and the reason is they can offer a tri-party service as part of the feelgood factor”.

“Tri-party repo is the way the market is moving,” agrees Ann Hunt, global head of product de-velopment - securities lending, at Chase Manhattan in London. “Tri-party is also a useful tool for securities lending, but whether everyone will use it is doubtful, as most custodians already have their own operations in place.”“

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