Collateral has been used for hundreds of years to provide security against the possibility of a default by the opposing party in a trade. Collateral management began in the 1980s, with bankers Trust and Salomon Brothers obtaining guarantees against credit commitments. There were no legal standards, and most of the calculations were done manually on spreadsheets. Coverage of derivatives commitments spread in the early 1990s. Standardization began in 1994 with the first documentation of the ISDA.  “Technology can never replace your own compliance and due diligence procedures when it comes to knowing your customer. If a client intends to take you and not repay your investment, they find a way to do so, regardless of the caliber of the collateral management team on site,” meyer explains. These motivations are linked, but the overwhelming driver of the use of guarantees is the desire to protect against credit risks.  Many banks do not act with counterparties that do not have collateral agreements. This is usually the case for hedge funds.
Missing or stolen shares, bribes, fraud, defaults or food that rot in silos are some of the risks that lenders and collateral managers face. In the modern banking sector, guarantees are mainly used in over-the-counter transactions. However, collateral management has evolved rapidly over the past 15 to 20 years, with the increasing use of new technologies, competitive pressure in the institutional financial industry and increased counterparty risk due to the widespread use of derivatives, asset pool securitization and leverage. As a result, collateral management is now a very complex process, with interconnected functions involving multiple parties.  Since 2014, large pension funds and sovereign wealth funds, which generally hold a high level of high-quality securities, have been exploring ways such as converting security to earn fees.  To combat this, collateral directors often employ managers from expatriate countries at their main sites: someone who has not grown up on the site and has not had the chance to build relationships with people seeking agreement. Staff rotations are also recommended. “Many banks do not have the authority to take the risk for developing countries, the risk of embezzlement and the risk of fraud. Collateral management could thus contribute to the structuring of African-based commercial financing, for example with development finance institutions that provide some of the debt with commercial banks,” says Richard Wilkes, Senior Partner, Structured Trade and Commodities Financing at Norton Rose Fulbright.