When young finance undergraduates are searching for career entries, collateral management isn’t one profession that immediately leaps out to them. The front office functions of investment banking, sales & trading and equity research have been far more heavily marketed as well as the buyside jobs in hedge funds, venture capital and private equity. However, given the increasing role of collateral management in the modern investment bank, there are more of these roles being offered to graduates and they are potentially a highly rewarding way to start a career. In the bank of 2017, capital growth and capital preservation are treated as equal priorities. Therefore, when it comes to making money versus saving money, banks are equally willing to adopt the “penny saved is a penny earned” approach. As collateral management is one of the key ways for banks to potentially save money, the rise in this type of job has been predicated by the astounding growth of the industry at large.
The role of collateral management is essentially to move different financial products between two counterparties trading with each other that covers the total exposure to the portfolio that is underlying. In simpler terms, if a bank lent a mortgage to a buyer, then the buyer is then responsible for paying back that mortgage with interest to the bank over a fixed time period. In the event of a buyer default or inability to pay the mortgage, the bank holds the right to seize the house and sell it at market price to cover their losses. The house in this scenario represents the collateral that the bank has received from the buyer. It is the same logic with securities. When buyers and sellers enter into a transaction, the seller posts some sort of collateral (normally cash) that the buyer can lay claim to if the seller fails to make the scheduled payments. When counterparties default on their obligations, the collateral is the protective insurance that insulates losses to some degree. If the collateral is marked to market and found to be short of the exposure amount, the bank will then issue a margin call which is essentially a call for more collateral to be posted by the buyer. In the days after the Lehman Brothers collapse, there were a lot of these margin calls as the value of securities dwindled at an alarming rate.
In today’s banking environment, collateral management services are more than just a back office role that move collateral between one place to another. Greater emphasis is now placed on the efficiency and optimization of collateral in order to use it in the most cost-efficient way. This means identifying opportunities where the posted collateral can e “recycled” and placed to earn the highest level of yield while the transaction is undergoing. This represents an essential aspect of a financial institution’s non-core operations and can be a significant component of non-operational income. In addition to that, the collateral management analyst can also get exposure to various types of products as most ISDA agreements have the flexibility to allow for multiple collateral products.
All in all, the collateral management career is one where a young analyst can gain exposure to a section of the bank that is only likely to grow in importance over the next few years if history is any indication. With a clear focus on optimizing collateral and improving valuation procedures and visibility, this is a white space opportunity for new players to come in and make it their own. The industry is still in progress, processes are still being refined and there is a large untapped arena that can be taken advantage of when it comes to measuring efficiency of valuation. With a sizeable market worldwide, collateral management may even be poised to take on a greater role within the banking core operational model – a move that would be in line with the current trend focusing on capital preservation and savings.
