ISDA MAKES 22 RECOMMENDATIONS TO IMPROVE COLLATERALIZATION IN PAPER ON BENEFITS AND RISKS ISSUED AT GENERAL MEETING

VANCOUVER, Wednesday, March 24, 1999 - The International Swaps and Derivatives Association (ISDA) issued at its annual meeting today an assessment of how collateralization and collateral management programs for privately negotiated derivatives transactions performed during the periods of market volatility in 1997-1998. The ISDA Review follows the ISDA Guidelines for Collateral Practitioners published last year, which was an introduction to collateral management practices. The ISDA Review, based on collateral use by senior practitioners in 1997 and 1998, documents a strong case for using this tool. Analyzing their experiences, the ISDA Review assesses the effectiveness of current collateral management processes and proposes action plans that reflect the 22 recommendations. It suggests that individual institutions consider the applicability of implementing measures designed to:

• Understand the role of collateral in credit risk management,
• Evaluate the organizational structure and operational risks of the collateral management function,
• Minimize collateral-related disputes,
• Review policies regarding acceptable collateral types, haircuts, cash, and initial margin requirements, and
• Create awareness of the legal environment in which the collateral function operates.

The ISDA Review also proposes that ISDA:

• Establish working groups to discuss specific recommendations affecting the industry including collateral types, haircut methodology(including the possibility of a benchmark asset pricing service), and cash collateral,
• Review and enhance the structure, provisions, and negotiating mechanisms of the existing ISDA standard documents,
• Continue its survey of the secured transaction laws in various jurisdictions, and
• Continue its efforts to advance cross-product netting and cross-product collateralization.

Finally, legislators and regulators are urged to:

• Review regulatory requirements to remove barriers to advancements in risk management methodologies and to facilitate the advancement of cross product netting and cross product collateralization, and
• Consider simplification and modernization of laws governing secured transactions.

The paper was presented by Michael Clarke, vice president at J.P. Morgan; David J. Maloy, managing director at Warburg Dillon Read, and Ms. Hinko. Mark D. Harding, chairman of ISDA and European general counsel at Warburg Dillon Read, called the paper "a significant study on current collateralization that gives direction to further improvements in best practices and regulation." ISDA expects to provide leadership in implementing the proposed action plans, Mr. Harding said.

The ISDA Review found practitioners in general agreement that collateral is a highly successful way to deal with credit risk. It describes how collateral agreements can significantly reduce credit risk in specific instances and suggests mechanisms for reducing the associated risks. Its analysis focuses on the following nine areas:

• Credit analysis and collateralization
• Managing the risks of collateralization
• Dispute resolution
• Shortening the collateral cycle to reduce risk
• Expansion of collateral types
• Initial margin
• Legal and documentation issues
• Cross-product netting and collateralization
• Substitutions and liquidity

Lessons taught by the stresses encountered over the past two years included problems arising over the quality of internal data, the speed of market movements and extreme situations such as the Russian debt moratorium and consequent disruptions in pricing transparency.

The ISDA 1999 Collateral Review will be distributed shortly to ISDA members in print form. (Click here for a copy in PDF format.)