Reducing Exposure

Measuring and managing exposure is usually the concern of people on the credit risk and collateral management teams. They have overlapping views of the relationship between your firm and your counterparties.

The Credit Risk team works to manage the long-term amount of business between your firm and your counterparties. The collateral team works within those limits to transform and mitigate exposures.

The cycle of activity includes:

• Setting the credit limit for a counterparty
  
• Monitoring trading activity within those limits
  
• Measuring exposure
  
• Delivering or receiving assets to cover those exposures
  

There are three fundamental ways to limit or reduce risk:

• Reaching a limit results in a stop to trading
  
• Executing risk reducing trades
  
• Covering exposure with assets
  

Collateral management is a common procedure to limit the consumption of credit limits. Offsetting an exposure against risk, the credit limit remains available for more trading.

Collateral management is a mechanism is to transform risk into assets. By holding a bond to cover an exposure, you then need to measure and manage the risk on the bond itself.

New risks resulting from collateral management include:

• Concentration risk of the bonds
  
• Default of the bond issuers
  
• Price volatility of the bonds
  
• Liquidity of the bonds
  

These new risks, which may become the responsibility of your Treasury team, also need managing.