A Global Solution For Risk Management

The dramatic growth of international financial markets has greatly increased liquidity and efficiency. Innovative instruments such as swaps and other over-the-counter derivatives have permanently transformed the financial landscape, providing new opportunities for treasurers and traders alike. But growth and innovation have also spawned additional risks, posing a major challenge for market participants as they seek to expand their business and control risk through the use of collateral. Now Cedel Bank, in conjunction with eight leading market participants, has created a global, industry-wide solution to this problem, offering a state-of-the-art, on-line collateral management service known as the Global Credit Support Service (GCSS).

GCSS is the first fully-automated, global, real-time book-entry service for multicurrency asset movements open to anyone in the financial markets, anywhere, at any time. It was developed by the market for the market, drawing on the expertise of Cedel Bank and eight of the world's leading financial institutions—Bank of America, Banque Paribas, Chase Manhattan Bank and Chemical Bank (which have now merged), Dresdner Bank, the European Bank for Reconstruction and Development, Morgan Stanley, and Salomon Brothers. All of these institutions have signed up as initial users of the service and the customer list continues to expand. Launched in September 1996, GCSS provides the first automated online process for collateral management in the derivatives marketplace, while offering both dealers and end-users maximum flexibility in the types of eligible collateral and the terms and conditions it can implement. The service can also be used to move collateral and payments between exchanges, clearing houses and any other counterparties, centralizing all your collateral management activity. In fact, one of the initial customers includes an international exchange, which has chosen the service for all its margin, collateral and payment requirements associated with four new indices targeted for Eastern Europe. As a customer of GCSS, this exchange and its members can now be accessed through the service by all other customers of GCSS, dramatically expanding the counterparty network.

Comprehensive risk mitigation involves proper risk assessment, binding legal agreements, the swift and secure movement of collateral between counterparties and enforcement of claims on these assets in the event of a default. GCSS helps customers achieve all these goals on a global, real-time basis, allowing them to minimize risk in the trading of derivatives, maximize asset efficiency and cut their funding and administrative costs. Indeed, by providing the first widely accepted, industry standard platform for collateral management, GCSS can help reduce systemic market risk while at the same time removing obstacles to the market's growth.

The Benefits of GCSS

The worldwide growth of financial markets is based in part on an enhanced ability to manage risk. In the case of derivatives markets, many participants control risk by periodically marking to market their positions, netting bilateral exposure to each counterparty and demanding collateral—generically known as credit support—when the net exposure exceeds predetermined limits. Collateralization as a means of controlling credit exposure is steadily rising, as financial institutions expand their business with new and existing counterparties, but need to comply with tighter capital requirements imposed by regulators. However, the job of tracking and calculating exposure, receiving and delivering collateral assets and all the associated record keeping can represent an enormous burden, especially when it involves multiple counterparties, securities and currencies. For many participants, it is a costly, inefficient and labor-intensive process fraught with unnecessary risk.

GCSS provides a global, industry-wide solution for all market participants, large and small. It has the flexibility to accommodate a wide range of collateral assets covering exposures under all kinds of bilateral master agreements, utilizing the existing documentation. Developed with substantial input from customers, the system is easy to use, requiring only a personal computer running Windows™ software with local access via modem to Cedel Bank's secure network and host data base in Luxembourg. It is protected by password access, and features encrypted communications and comprehensive backup systems.

As a fully-automated, real-time, global multicurrency network, GCSS radically simplifies the task of collateral management, optimizing the use of assets, increasing efficiency and reducing costs. It allows customers to re-use available assets, move book-entry assets in small pieces and streamline back-office administration through automated record keeping and monitoring. By alleviating credit exposure concerns and providing an effective collateral management infrastructure, GCSS enables customers to increase their trading activity with existing counterparties as well as take on new counterparties.

Everything that GCSS does conforms to fully flexible bilateral parameters established in advance by the two counterparties; it takes no independent action. This protects the counterparties, since both have agreed to the operating rules of GCSS and can monitor their positions on a real-time basis. In the event of a disagreement, any counterparty can instruct the service to block all further movement of ownership interests. As a result, GCSS is secure, because both parties must regularly report and agree on their net bilateral exposure and at some point one of them must put up collateral, preventing any snowballing of obligations.

The enhanced legal protection of the transfer of title system and Luxembourg fiduciary structure also protects customers and their counterparties, reducing legal uncertainty. With assets in book-entry form domiciled in Luxembourg under the custody of Cedel Bank, customers can immediately seize collateral assets in the event of a counterparty default or bankruptcy.

In short, GCSS is a global, real-time service for entering and agreeing bilateral credit exposures; and implementing substitutions, returns or deliveries. It uses an intelligent technology system for minimizing the assets that any GCSS customer must provide to meet its collateral obligations to all other participating counterparties and is a risk management service that revalues collateral daily against market prices and compares values to debt obligations.

An Overview Of the Service

How can you participate in GCSS?

First, you sign a standard fiduciary agreement with Cedel Bank. This is the basic governing document for participation in GCSS and covers all the service's operating arrangements. You and your counterparties also sign a brief addendum to your existing bilateral agreements, indicating you can now use GCSS to implement your collateral movements. After installing the GCSS software, receiving a password, account number, and comprehensive on-site training, you are ready to begin using the system.

How does the system work?

New customers first enter the terms of their bilateral agreements, specifying the parameters that will be used for each counterparty, in effect telling GCSS how and when it should process and respond to information. These terms cover all the principal variables, including the law under which the bilateral agreement was signed; the kinds of assets that will be eligible for use as collateral and whether they will be valued at a discount from their face amounts; how often exposures will be reported and collateral assets marked to market; the thresholds for requiring initial collateral and making subsequent margin calls; the minimum transfer amounts and whether collateral can be re-used by the counterparty in possession. GCSS can handle more than 90,000 different securities in 37 currencies. You also choose which timeline to use for each agreement—the system currently operates two 24-hour cycles, an Asian-European cycle and an American cycle—in order to meet the needs of counterparties in various time zones.

Many customers have different agreements with numerous counterparties. Nevertheless, GCSS can implement all of them automatically and simultaneously, keeping within the parameters you have dictated in each case. In addition, GCSS can implement any preferences or priorities you may have regarding the movement of your own collateral assets and your dealings with counterparties, with the aim of achieving the best use of available assets to satisfy all your collateral commitments.

After entering all the specific bilateral terms, you can begin notifying GCSS of your net aggregate exposure to each counterparty. As soon as the counterparty enters its calculation of the net exposures for the same agreement, the system displays both entries on the screens of the two customers and, in case of any discrepancy, can automatically resolve the difference within pre-arranged guidelines (for example, splitting the difference if the gap is less than a specified tolerance amount).

The mutually agreed net aggregate exposure is the basis for calculating any collateral requirement, which GCSS performs by periodically marking the collateral assets to market and determining the adequacy of coverage. If necessary, GCSS can automatically issue a margin call and transfer collateral between the parties, in response to preset coverage requirements, preferences and priorities, although customers can also choose to move assets manually if they wish.

Summary of Benefits Financial Risk Control Operational Lower funding costs Tailored parameters Reduced operating costs Increased ability to trade Instant awareness of shortfalls Real-time reports Systemic liquidity Robust legal framework High-speed transfers

Customers deposit collateral assets in the service by physically delivering cash or specifically identifiable securities to Cedel Bank or any of its agent banks around the world. The assets are then immobilized. GCSS simply tracks the movement of ownership interests in the assets as varying amounts are delivered, returned and reused on a book-entry basis, essentially providing real-time movement capability for multicurrency assets.

Collateral assets can be brought into and removed from the service twice a day during GCSS batch processing, with one exception—customers with an account at the Fed in the United States can move U.S. government securities into and out of their GCSS account at any time during business hours in New York, through a dedicated GCSS-Fedwire link. Once in the service, assets can be moved round the clock between counterparties worldwide, whether or not local markets are open.

What are the special value-added features of GCSS?

Twice a day, GCSS runs sophisticated optimization routines, which allow customers to harness the system's powerful technology to achieve the most efficient use and distribution of assets in accordance with individual preferences, priorities and the terms of bilateral agreements. During this period, GCSS automatically returns any excess collateral, identifies the cheapest assets to deliver and redeploys assets to cover any shortfalls, with the aim of covering all the customer's obligations in the optimal way, executing the transfers simultaneously regardless of the number of counterparties.

GCSS immediately notifies customers if there is a shortfall of assets for use as collateral, enabling the deficit to be cured in seconds. Moreover, only one physical delivery of additional assets to Cedel Bank is needed; GCSS can break it up into the required transfer amounts and deliver them to the appropriate counterparties. In addition, GCSS performs standard safekeeping functions, including monitoring corporate actions and changes in securities ratings, in case they affect the value or eligibility of collateral assets. The service also provides a highly efficient substitution capability, even when local markets are closed, exchanging assets simultaneously and thereby eliminating substitution risk.

Where customers have a net positive securities position, and these securities are re-usable under the bilateral agreement, they can be used for other transactions, including repos, securities lending and sales outside GCSS. Cedel Bank also provides specialist services in these areas if required. The optimal re-use of collateral among multiple accounts is a key source of value in GCSS, enabling the service to minimize the net amount of collateral required to cover all counterparties on a multilateral basis.

In summary, GCSS is a state of the art global solution for all your collateral management needs, providing numerous benefits across all functional areas, no matter what the size of your organization.

For further information

If you would like to know more about Cedel Bank's Global Credit Support Service, please contact our GCSS Sales Specialists, Anthony Feld in New York on 212 775 1900 or Iain Barbour in London on +44 (0) 171 216 7035 or your Commercial Officer at our Regional Office.