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Trading and
Capital-Markets Activities Manual
Trading
Activities: Counterparty Credit Risk and Pre-settlement Risk (Continue)
Source: Federal Reserve System
(The complete Activities
Manual (pdf format) can be downloaded from the Federal Reserve's web
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Counterparty Credit Risk and Pre-settlement Risk
COUNTERPARTY CREDIT RISK LIMITS
Exposure-monitoring and limit systems are
critical to the effective management of counterparty credit risk. Examiners
should focus special attention on the policies, practices, and internal
controls of banking institutions. An effective exposure-monitoring system
consists of establishing meaningful limits on the risk exposures an institution
is willing to take, independent ongoing monitoring of exposures against
such limits, and adequate controls to ensure that reporting and meaningful
risk-reducing action takes place when limits are exceeded. Since an effective
exposure-monitoring and limit process depends on meaningful exposure-measurement
methodologies, examiners should closely evaluate the integrity of these
systems at institutions that may have inadequate exposure-measurement
systems-especially regarding the estimation of potential future exposures.
Overly conservative measures or other types of less-than-meaningful exposure
measurements can easily compromise well-structured policies and procedures.
Such situations can lead to limits being driven primarily by customer
demand and used only to define and monitor customer facilities, instead
of using limits as strict levels, defined by credit management, for initiating
exposure-reducing actions.
Limits should be set on the amounts and types of transactions authorized
for each entity before execution of any trade. Distinct limits for pre-settlement
and settlement risk should be established and periodically reviewed and
recon-firmed. Both overall limits and product sublimits may be established.
For example, a customer may be assigned a foreign-exchange trading line,
while interest-rate or cross-currency swaps are approved against the general
line on a transaction-by-transaction basis. In some cases, the approach
to assigning sublimits reflects the pace of transactions in the marketplace
as well as the amount of credit risk (largely a reflection of tenor).
The sum of product-specific sublimits may well exceed the aggregate limit,
reflecting management's experience that all sublimits are not used simultaneously.
In such cases, however, the organization should have sufficient monitoring
of global credit exposures to detect a breach of the global limit.
The frequency with which credit exposures are monitored depends on the
size of the trading and derivatives portfolios and on the nature of
the trading activities. Active dealers should have counterparty credit
exposure monitored daily. Irrespective of how credit exposure is monitored,
the replacement cost should be calculated daily and compared to the approved
potential exposure figure for validity.
Unusual market movements may lead to rapid accumulation of credit exposure.
The creditworthiness of counterparties can also change. Between its regular
reviews of credit exposures, the institution should have a mechanism that
guarantees timely recognition of either unusual credit-exposure buildups
or credit deterioration in a counterparty. For institutions that are dealers
in these markets, the monitoring should be very frequent, and regular
reviews should be conducted with the same frequency as for other significant
credit customers.
Management should have procedures for controlling credit-risk exposures
when they become large, a counterparty's credit standing weakens, or the
market comes under stress. Management should show clear ability to reduce
large positions. Common ways of reducing exposure include halting any
new business with a counterparty and allowing current deals to expire,
assigning transactions to another counterparty, and restrucEagle Tradersg
the transaction to limit potential exposure or make it less sensitive
to market volatility. Institutions can also use many of the credit enhancement
tools mentioned earlier to manage exposures that have become uncomfortably
large.
INSTITUTIONAL INVESTORS AND HEDGE FUNDS
Examiners should pay increasing attention
to the appropriateness, specificity, and rigor of the policies, procedures,
and internal controls that institutions use in assessing, measuring, and
limiting the counterparty credit risks arising from their trading and
derivative activities with institutional investors in general, and particularly
with hedge funds. In the area of counterparty assessment, institutions
doing business with institutional investors and hedge funds should have
sufficient information on which to assess the counterparty and its inherent
risks, including information on total leverage, both on- and off-balance-sheet,
and firm strategies. Banks should conduct in-depth due-diligence reviews
of the effectiveness of a counterparty's risk-management systems and capabilities
and its internal control environment to make effective decisions regarding
the level of risk they are willing to assume. Institutions should be cautioned
to obtain supporting documentation for the claims of fund managers.
Counterparty credit risk management should emphasize comprehensive stress
testing across a variety of scenarios, with particular focus on possible
asset or position concentrations. Institutions should also determine the
investor's or fund's ability to stress test its portfolio. In limiting
counterparty credit risks through the use of collateral and other credit
enhancements, it should be recognized that standard arrangements that
may be suitable for most counterparties may not be suitable for counterparties
that have the potential to quickly change their portfolios, such as hedge
funds. For example, 12-month rolling average close-out provisions may
be inappropriate for counterparties engaged in active trading, where a
prior month's gains can mask serious losses in the current month. Institutions
that deal with institutional investors and hedge funds should have the
policies, procedures, and internal controls in place to ensure that these
exposures are measured, monitored, and controlled by management on an
on-going basis.
The Basle Committee on Banking Supervision released a report that analyzed
the risks posed by hedge funds to creditors and published sound practices
standards for interactions with hedge funds. The sound practices standards
identified areas in which bank practices could be enhanced, including-
• establishing clear policies and procedures that define the bank's
risk appetite and drive the process for setting credit standards;
• obtaining adequate information on which to base sound judgments
of counterparty credit quality;
• performing adequate due diligence, including setting standards
for risk management by counterparties that are commensurate with the level
of sophistication and complexity of their activities;
• developing meaningful limits for derivatives counterparties and
more accurate measures of potential future exposure;
• adequately assessing and measuring unsecured exposures under
collateralized derivatives transactions, and setting meaningful credit
limits based on such assessments;
• adequately stress testing counterparty credit risk under a variety
of scenarios that take into account liquidity effects, and incorporating
results into management decisions about risk taking and limit setting;
• closely linking non-price terms, including collateral arrangements
and termination provisions, to assessments of counterparty credit quality;
and
• timely monitoring counterparty transactions and credit exposures,
including frequently reassessing banks' large exposures, counterparty
leverage, and concentration of counterparty activities and strategies.
UNNAMED COUNTERPARTIES
Institutions that deal in products such
as foreign exchange, securities, and derivatives sometimes face situations
in which they are unaware of a counterparty's identity. Investment advisors
or agents typically conduct trades on behalf of their investment-management
clients and do not provide the names of the ultimate counterparty on the
grounds of confidentiality. In this situation, the dealing institution
will most likely never know the identity of its counterparties.
Because institutions may not be able to assess the creditworthiness of
unnamed counterparties in advance, they should develop policies and procedures
that define the conditions under which such transactions can be conducted.
Exposures arising from these transactions should be closely monitored
and controlled. Given the potential reputational risks involved, transactions
with unnamed counterparties should be restricted to reputable agents and
firms. Institutions with significant relationships with investment advisors
who trade on behalf of undisclosed counterparties may wish to establish
agency agreements with those advisors. These agreements can provide for
a series of representations and warranties from the investment advisor
on a variety of issues including compliance with local and national laws
and regulations, particularly on money-laundering regulations.
Techniques used to reduce credit exposure to undisclosed counterparties
include setting limits on the aggregate amount of business or on the types
of instruments or transactions conducted with unnamed counterparties.
In addition, institutions often pay particular attention when processing
an agent's trades for an unnamed counterparty. An effective and efficient
backoffice process helps to ensure that the institution is aware of the
size of such exposures on a timely basis.
Similarly, institutions often manage the settlement process with unnamed
counterparties more closely than with traditional trading counterparties.
Institutions often set settlement limits with unnamed counterparties so
that large sums are not settled on a single day. Institutions sometimes
develop procedures that ensure management is made immediately aware of
settlement failures by unnamed counterparties.
BLOCK TRADES WITH INVESTMENT ADVISORS
Frequently, investment advisors or agents
will bundle together trades for several clients, particularly in the case
of mutual funds and hedge funds.2
Most of these trades are accompanied by information about how the trade
should be allocated among the funds for which it was executed, or they
are subject to standing allocation information. Occasionally, investment
advisors may fail to give institutions timely allocation information.
Institutions should be concerned that such delays do not become habitual.
When significant investment advisor relationships exist, institutions
should adopt policies requiring that all transactions be allocated within
some minimum period (for example, by the end of the business day). The
credit department should be promptly notified of any exceptions to such
policies.
Many institutions track the allocation arrangements made by investment
advisors. While late allocations or frequent changes to allocation arrangements
are often symptomatic of backoffice problems at the investment advisor,
they could also indicate that the investment advisor is engaging in unfair
allocation.
Sometimes the allocations provided by investment advisors include counterparties
that may
not have established credit lines with the institution. Institutions should
endeavor to minimize such situations and may wish to limit the percentage
of any trade that can be allocated to counterparties that do not have
an existing credit line with the institution.
MANAGEMENT INFORMATION SYSTEMS
Management information systems (MIS) used
to control counterparty credit risk include systems to monitor exposure
levels; track customer limits and limit excesses; and, when used, value
and track collateral. Important inputs to these systems include transaction
data, current market values, and estimated potential credit exposures.
The primary purpose of these systems is to provide comprehensive, accurate,
and timely credit information to credit-risk-management personnel, front-office
personnel, business-line and other senior management, and, ultimately,
the board of directors. Institutions should ensure that their credit MIS
are adequate for the range and scope of their trading and derivative activities
and that there are appropriate controls in place to ensure the integrity
of these systems. As part of the normal audit program, internal audit
should review credit MIS to ensure their integrity.
A critical element of MIS is their timeliness in reflecting credit exposures.
For derivative contracts, institutions should be able to update the current
market values and potential credit exposures of their holdings throughout
the life of a contract. The frequency of updates for credit-risk-management
purposes often depends on the complexity of the product and the volume
of trading activity. More sophisticated systems provide intraday exposure
numbers that enable the front office to determine, without any additional
calculations, whether a proposed deal will cause a credit excess.
Institutions that use collateral to manage credit risk usually maintain
collateral-management systems for valuation and monitoring purposes. The
sophistication of an institution's collateral management system should
reflect the size of the collateral program, frequency of collateral revaluations
and associated credit-exposure calculations, nature of collateral-posting
events, and location of the collateral. The most effective collateral-management
systems are global and have the ability to identify, post, value, stress
test, and monitor collateral. When collateral-management systems are able
to feed data into the front-office's credit-line-availability system,
an institution can factor collateral into credit-approval decisions and,
consequently, have a more accurate picture of unsecured credit risk.
Institutions often maintain databases that detail the extent to which
netting is applicable for a given counterparty. Depending on whether netting
is applicable, obligations are presented on a net or gross basis in credit-monitoring
reports.
Credit MIS should furnish adequate reports to credit personnel and business-line
management. Daily reports should address significant counterparty line
usage and exceptions to limits. Less frequent reports on the maturity
or tenor of credit exposures, sector and industry concentrations, trends
in counterparty exposures, trends in limit excesses, ''watch lists,''
and other pertinent reports are also appropriate. Periodic summary reports
on credit exposures should also be presented to senior management and
the board.
DOCUMENTATION OF POLICIES AND PROCEDURES
Current and sufficient documentation is
critical to the effective operation of a credit-risk-management program
and is necessary to ensure that the program is consistent with the stated
intentions of senior management and the board. The institution's credit
policy manual is an important tool for both auditors and examiners, as
well as an important resource for resolving any disputes between credit-risk
management and traders or marketers.
All policies and procedures specific to credit-risk management for trading
should be added to the financial institution's overall credit policy manual.
Procedures should include limit-approval procedures, limit-excess and
one-off approval procedures, exposure-measurement methodologies, and procedures
for accommodating new products and variations on existing products. Policies
should also address the methodologies for assessing credit-loss reserves
for trading operations. When established, such reserves should take into
account both current and potential future exposure. Credit-approval documentation
should also be closely tracked by the credit-risk-management function.
All limit approvals should be filed by counterparty and made available
to traders so that they know the available limit to a counterparty before
entering into a deal. Signed over-limit or one-off approvals should also
be tracked down and kept in a file for historical records. A log should
be maintained for all missing signed approvals, and approvals for new
products should be maintained.
1. See section 3030.1, ''Futures Brokerage
Activities and Futures Commission Merchants,'' as well as the Federal
Reserve's Bank Holding Company Supervision Manual.
2. The Securities and Exchange Commission, in a number of no-action letters,
has permitted this practice as long as the advisor does not favor any
one client over another, has a written allocation statement before the
bundled order was placed, and receives the client's written approval.
See the SEC letters SMC Capital, Inc. (September 5, 1995); Western Capital
Management, Inc. (August 11, 1977).
Counterparty Credit Risk and Pre-settlement
Risk
Examination Objectives
1.To evaluate the organizational structure of the credit-risk-management
function.
2. To evaluate the adequacy of internal credit-risk-management policies
and procedures relating to the institution's capital-markets and trading
activities and to determine that sufficient resources and adequate attention
are devoted to the management of the risks involved in growing, highly
profitable, or potentially high-risk activities and product lines.
3. To ensure that actual operating practices reflect such policies.
4. To identify the credit risks of the institution.
5. To determine if the institution's credit-risk-measurement system has
been correctly implemented and adequately measures the institution's credit
risks.
6. To determine if the institution's credit-risk-management processes
achieve an appropriate balance among all elements of credit-risk management,
including both qualitative and quantitative assessments of counterparty
creditworthiness; measurement and evaluation of both on- and off-balance-sheet
exposures, including potential future exposure; adequate stress testing;
reliance on collateral and other credit enhancements; and the monitoring
of exposures against meaningful limits.
7. To determine how the institution measures difficult-to-value exposures.
8. To determine if senior management and the board of directors of the
institution understand the potential credit exposures of the capital-markets
and trading activities of the institution.
9. To ensure that business-level management has formulated contingency
plans in the event of credit deterioration and associated market disruptions.
10. To evaluate the adequacy of the policies, procedures, and legal and
operational support relating to the institution's use of credit enhancements.
11. To determine if the institution has implemented adequate policies
and procedures that are sufficiently calibrated to the risk profiles of
particular types of counterparties and instruments to ensure adequate
credit-risk assessment, exposure measurement, limit setting, and use of
credit enhancements.
12. To ensure the comprehensiveness, accuracy, and integrity of management
information systems that analyze credit exposures and to ensure that the
methodology and automated processing can accommodate netting and other
legal offset agreements, if applicable.
13. To determine if the institution's credit-risk-management system has
been correctly implemented and adequately measures the institution's exposures.
14. To determine if the institution has an effective global risk-management
system that can aggregate and evaluate market, liquidity, credit, settlement,
operational, and legal risks, and that management at the highest level
is aware of the institution's global exposure.
15. To determine if the institution is moving in a timely fashion to enhance
its measurement of counterparty-credit-risk exposures, including the refinement
of potential future exposure measures and the establishment of stress-testing
methodologies that better incorporate the interaction of market and credit
risks.
16. To recommend corrective action when policies, procedures, practices,
internal controls, or management information systems are found to be deficient.
Counterparty Credit Risk and Pre-settlement Risk
Examination Procedures
These procedures are processes and activities that may be considered in
reviewing the credit-risk-management of trading and derivative operations.
The examiner-in-charge will establish the general scope of examination
and work with the examination staff to tailor specific areas for review
as circumstances warrant. As part of this process, the examiner reviewing
a function or product will analyze and evaluate internal audit comments
and previous examination workpapers to assist in designing the scope of
the examination. In addition, after a general review of a particular area
to be examined, the examiner should use these procedures, to the extent
they are applicable, for further guidance. Ultimately, it is the seasoned
judgment of the examiner and the examiner-in-charge as to which procedures
are warranted in examining any particular activity.
1. Review the credit-risk-management organization.
a. Check that the institution has a credit-risk-management function with
a separate reporting line from traders and marketers.
b. Determine if credit-risk-control personnel have sufficient authority
in the institution to question traders' and marketers' decisions.
c. Determine if credit-risk management is involved in new-product discussions
in the institution.
2. Identify the institution's capital-markets and trading activities and
the related balance-sheet and off-balance-sheet instruments. Obtain copies
of all risk-management reports prepared by the institution. Using this
information, evaluate credit-risk-control personnel's demonstrated knowledge
of the products traded by the institution and their understanding of current
and potential exposures.
3. Obtain and evaluate the adequacy of risk-management policies and procedures
for capital-markets and trading activities.
a. Review credit-risk policies, procedures, and limits. Determine whether
the risk-measurement model and methodology adequately address all identified
credit risks and are appropriate for the institution's activities. Review
the methodologies used to measure current exposure and potential exposure.
b. Review credit-administration procedures.
• Determine how frequently counterparty credit conditions are analyzed
and lines reviewed. This should be done no less frequently than annually.
• Assess whether management has demonstrated an ability to identify
downgrades in creditworthiness between reviews.
• Determine if credit-risk-management staff demonstrate an ability
to work out of positions with counterparties whose credit quality has
deteriorated.
• Check that limits are in place for counterparties before transacting
a deal. If the institution relies on one-off approvals, check that the
approval process is as formal as that for counterparty limits.
c. Review contingency credit-risk plans for adequacy.
d. Review accounting and revaluation policies and procedures. Determine
that revaluation procedures are appropriately controlled.
e. Determine the extent to which management relies on netting agreements.
Determine if aggregation of exposure assumes netting, and check that netting
agreements are in place and that legal research is performed to justify
management's confidence in the enforceability of the netting agreements.
4. Determine the credit rating and market acceptance of the institution
as a counterparty in the markets.
5. Obtain all management information analyzing credit risk.
a. Determine the comprehensiveness, accuracy, and integrity of analysis.
b. Review valuation and simulation methods in place.
c. Review stress tests analyzing changes in credit quality, including
deterioration of credit due to changing macroeconomic conditions. Review
stress-testing methodologies to determine the extent to which they incorporate
both credit and market risk.
d. Review potential future exposure calculations to determine whether
they reflect realistic measures of exposure in both normal and stressed
markets.
e. Determine whether the management information reports accurately reflect
risks and whether reports are provided to the appropriate levels of management.
6. Determine if any of the institution's counterparties have recently
experienced credit downgrades or deteriorations and whether the institution's
trading activities have been affected. If so, determine the institution's
response.
7. Review documentation that evidences credit-risk management's adherence
to its program.
a. Obtain copies of written approvals for limit excesses or one-off approvals.
Determine the timeliness of these approvals.
b. Select a sample of master agreements to ensure that each counterparty
with whom management nets exposure for risk-management purposes has signed
a master agreement. Review the master agreement aging report of unsigned
master agreements to ensure adequate chasing procedures are in place.
8. Establish that the institution is following its internal policies and
procedures. Determine whether the established limits adequately control
the range of credit risks. Determine that the limits are appropriate for
the institution's level of activity. Determine whether management is aware
of limit excesses and takes appropriate action when necessary.
9. Determine whether the internal-audit and independent risk-management
functions adequately focus on growth, profitability, and risk criteria
in targeting their reviews.
10. Determine whether the institution has established an effective audit
trail that summarizes exposures and management approvals with the appropriate
frequency.
11. Determine that business managers have developed contingency plans
which reflect actions to be taken in times of market disruption (and major
credit deteriorations) to minimize losses as well as the potential damage
to the institution's market-making reputation. These should include controls
over the settlement process.
12. Obtain and evaluate the adequacy of policies and procedures relating
to the institution's use of credit enhancements.
a. Review collateralization policies and procedures.
• Determine the frequency of margin calls and portfolio and collateral
revaluations.
• Ensure that legal agreements are in place and that the fundamental
aspects of collateral relationships are specified in the agreements.
• Review the policies for determining the types of acceptable collateral,
haircuts on the collateral, and margin requirements.
b. Determine whether the institution has rehypothecation rights. Determine
whether appropriate policies and procedures are in place to manage the
risks associated with collateral rehypothecation.
c. Ensure that collateral-management systems and operational internal
controls are fully documented and able to support the institution's credit
enhancement activity.
13. Determine whether policies and procedures reflect the risk profiles
of particular counterparties and instruments. If the institution trades
with institutional investors, hedge funds, or unnamed counterparties,
determine if the institution has an overall limit on trading with these
types of counterparties.
14. Determine whether appropriate policies and procedures are in place
if the institution engages in block trades with investment advisors.
a. Determine if the institution has a policy that all trades not allocated
at the time of the trade must be allocated by the end of the trading day.
Determine whether exceptions to such a policy are monitored by the credit
area.
b. Determine how the institution deals with investment advisors who are
habitually late with allocation information.
c. Determine whether the institution limits the percentage of a block
trade that can be allocated to counterparties without credit lines.
15. Recommend corrective action when policies, procedures, practices,
internal controls, or management information systems are found to be deficient.
Counterparty Credit Risk and Pre-settlement Risk
Internal Control Questionnaire
1. Review the credit-risk-management organization.
a. Does the institution have a credit-risk-management function with a
separate reporting line from traders and marketers?
b. Do credit-risk-control personnel have sufficient credibility in the
institution to question traders' and marketers' decisions?
c. Is credit-risk management involved in new-product discussions in the
institution?
2. Identify the institution's capital-markets and trading activities and
the related balance-sheet and off-balance-sheet instruments and obtain
copies of all risk-management reports prepared.
a. Do summaries identify all the institution's capital-markets products?
b. Define the role that the institution takes for the range of capital-markets
products. Determine the instruments used to hedge these products. Is the
institution an end-user, dealer, or market maker? If so, in what products?
c. Do credit-risk-control personnel demonstrate knowledge of the products
traded by the institution? Do they understand the current and potential
exposures to the institution?
3. Does the institution have comprehensive, written risk-management policies
and procedures for capital-markets and trading activities?
a. Review credit-risk policies and procedures.
• Do the risk-measurement model and methodology adequately address
all identified credit risks? Are the risk-measurement model and methodology
appropriate for the institution's activities?
• Do the policies explain the board of directors' and senior management's
philosophy regarding illiquid markets and credit events (downgrades/deteriorations)?
b. Review credit-administration procedures.
• Are counterparty credit conditions analyzed and lines reviewed
with adequate frequency? (This should be done no less frequently than
annually.)
• Can management identify downgrades in creditworthiness between
reviews?
• Has credit-risk-management staff demonstrated an ability to work
out of positions with counterparties whose credit quality has deteriorated?
• Are limits in place for counterparties before transacting a deal?
If the institution relies on one-off approvals, is the approval process
as formal as that for counterparty limits?
c. Have limits been approved by the board of directors?
d. Have policies, procedures, and limits been reviewed and re-approved
within the last year?
e. Are credit-risk policies, procedures, and limits clearly defined?
f. Are the credit limits appropriate for the institution and its level
of capital?
g. Are there contingency credit-risk plans?
h. Are there appropriate accounting and revaluation policies and procedures?
i. Does management rely on netting agreements?
• Does aggregation of exposure assume netting?
• Are netting agreements in place and has legal research been performed
to justify management's confidence in the enforceability of the netting
agreements?
4. Has there been a credit-rating downgrade for the examined institution?
What has been the market response to the financial institution as a counterparty
in the markets?
5. Obtain all management information analyzing credit risk.
a. Is management information comprehensive and accurate and is the analysis
sound?
b. Are the simulation assumptions for a normal market scenario reasonable?
c. Are stress tests analyzing changes in credit quality appropriate? Are
the market assumptions reasonable given credit deterioration of concentrations?
Do stress-testing methodologies incorporate both credit and market risk?
d. Are calculations of potential future exposure realistic in both normal
and stressed markets?
e. Do management information reports accurately reflect risks? Are reports
provided to the appropriate levels of management?
6. Have any of the institution's counterparties recently experienced credit
downgrades or deteriorations? If so, how have the institution's trading
activities been affected and what was the institution's response?
7. Review documentation that evidences credit management's adherence to
its program.
a. Does the institution maintain copies of written approvals for limit
excesses or one-off approvals? Are these prepared in a timely manner?
b. Obtain a sample of master agreements. Are they appropriately signed?
Are they signed in a timely manner? Does the institution have an appropriate
chasing process to follow up on unsigned master agreements?
8. Is the institution following its internal policies and procedures?
Do the established limits adequately control the range of credit risks?
Are the limits appropriate for the institution's level of activity? Is
management aware of limit excesses? Does management take appropriate action
when necessary?
9. Do the internal audit and independent risk-management functions adequately
focus on growth, profitability, and risk criteria in targeting their reviews?
10. Has the institution established an effective audit trail that summarizes
exposures and management approvals with the appropriate frequency? Are
risk-management, revaluations, and closeout valuation reserves subject
to audit?
11. If any recent market disruptions affected the institution's trading
activities, what has been the institution's market response?
12. Does the institution have comprehensive written policies and procedures
relating to its use of credit enhancements?
a. Does the institution revalue collateral and positions with adequate
frequency?
b. Are the fundamental aspects of collateral relationships reflected in
legal agreements?
c. Does the institution have policies specifying the types of acceptable
collateral, haircuts on the collateral, and margin requirements? How often
are these policies reviewed by management?
d. Does the institution have rehypothecation rights?
• Does the institution have policies and procedures in place to
manage the risk that a third party holding rehypothecated collateral may
fail to return the collateral or may return a different type of collateral?
• Does the institution have measures in place to protect its security
interest in the rehypothecated collateral?
e. Do material-change triggers and closeout provisions take into account
counterparty-specific situations and risk profiles?
f. Are the collateral-management system and operational environment able
to support the institution's collateral activity?
13. Does the institution trade with institutional investors, hedge funds,
or unnamed counterparties?
a. Does the institution place an overall limit on trading with these types
of counterparties?
b. Are credit officers aware of all cases in which a counterparty's identity
is unknown?
14. Does the institution engage in block trades with investment advisors?
a. Does the institution have a policy that all trades not allocated at
the time of the trade must be allocated by the end of the trading day?
Are exceptions to the policy monitored closely by the credit area?
b. How does the institution deal with investment advisors who are habitually
late with allocation information?
c. Does the institution limit the percentage of a block trade that can
be allocated to counterparties without credit lines?
15. Do policies and procedures generally reflect the risk profiles of
particular counterparties and instruments?
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