While structured commodity bankers operating in sub-Saharan Africa have been using collateral management agreements (CMAs) in their stores for many years, the entry into force of Basel III regulation this year increases its importance as a useful risk reduction. The strengthening of regulations has highlighted the benefits of using collateral management agreements to secure commodity transactions in sub-Saharan Africa. But bankers still need to provide their own bases to minimize the risk of fraud and corruption, writes Rebecca Spong. “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. The practice of establishing guarantees in exchange for a loan has long been part of the business-to-business lending process. With more institutions looking for credit, as well as the introduction of new technologies, the scale of collateral management has increased. The increased financial risks have led to greater responsibility for borrowers and the objective of collateral management is to ensure that risks to the parties involved are as reduced as possible. You are less at risk if you have appointed the Collateral Manager: In the modern banking sector, guarantees are generally 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.
 Collateral management is the method of granting, auditing and advising collateral transactions, in order to reduce credit risk for unsecured financial transactions. The basic idea of collateral management is very simple, that cash or securities are transferred from one counterparty to another as credit risk security.  In the case of a swap transaction between Parties A and B, Part A gains market gain (MtM), while Part B makes a corresponding MtM loss. Part B then presents a form of guarantee for Part A to reduce the credit risk resulting from a positive mtM. The form of security is agreed before the contract begins. Collateral agreements are often bilateral. The security must be returned or counted in the opposite direction if the risk decreases. In the case of a positive MTM, an institution requires guarantees and, in the case of a negative MtM, they must reserve guarantees.  Collateral has been used for hundreds of years to provide security against the possibility of 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.