OTC Derivatives and Collateral – The Collateral Lifecycle – Throughout Lifetime of Trade – Collateral Substitution

This chapter describes the circumstances under which existing securities collateral is substituted with other collateral, and the process of achieving substitution. The typical reason for a collateral giver wishing to substitute bonds is that the bonds are required for delivery purposes in another transaction, for example: sale of securities; securities lending; and repo. The chapter describes a scenario which triggers substitution of bond collateral, whilst also illustrating the steps in the process. From the perspective of the collateral taker (i.e. the exposed party), providing the replacement collateral is eligible collateral under the credit support annex (CSA), they are obliged to accept the substitution request from the collateral giver. In attempting to effect substitution, both collateral giver and collateral taker must remain aware that unwanted exposures can be created. Furthermore, it is essential for a firm's accuracy of ongoing exposure calculations, that the cumulative collateral balance is updated following collateral substitution.