In the economic field, securities lending and collateral transformation are two interconnected terms - both designed to increase the protection of the involved parties against defaults. Collateral is needed with every transaction yet it must be either money or other liquid securities. And this is the part where lending interferes. But to make everything clear, we will discuss them separately and in the end redraw the obvious connection.

Collateral transformation is a major part of collateral management that allows the FCMs to finance the initial margin calls provided in a first instance by CCPs. This service can apply to both initial margin and variation margin and it can also be seen as an upgrade of the collateral. Everything can be achieved through three major steps resumed as it follows.

The client initiates an action by pledging the corporate bonds. Consequently, the FCM involved initiates a so-called repo transaction, with the purpose of transforming its bonds into cash. And with the resulted cash, the same FCM will pose a guarantee to the CCP, pledge that will cover the margin.

However, the process is not granted, as the FCM can reject financing the margin call whenever it considers that the markets are too tensed. Alternatively, if it does not want to apply such an extreme measure, the FCM may adopt a series of other strategies that can diminish the risks. One would be to increase the haircuts for the bond pledges, or to reduce the bond of eligibility.

On the other hand, let’s take a look into the notion of securities lending as well. Also referred to as stock lending, the action defines lending securities in between parties. Collateral management asks for a form of guarantee when requesting a loan. The process is subjected to several regulations inscribed in a protocol called Securities Lending Agreement. According to it, the one that barrows has to make the proof of eligibility by providing a form of collateral – be it liquidities, letter of credits, government securities and so on. In the end, the parties sign a contract.

The loan payment is also negotiated through a fee. The value of this fee however is determined according with the overall value of the securities that were loaned. Should the two parties settle for cash, that fee will be under the statute of a short rebate. Simply put, the entire interest resulting from the borrower will go the lender, rebating only a certain rate to the one who borrows. Anyone with access to a decent base of securities that can be lent is eligible to turn into a security lender.

As a last thing to mention about this requirement, its purposes are various and include: the facilitation of the trade settlement, of the short sale delivery, of the security finance or of a loan solicited by another borrower.

And this last observation takes us to the initially discussed term, which was collateral transformation. The fluctuations of the market make these two measures more vital than before and getting to know them and their functioning principles is a must for any entrepreneur.
Collateral transformation http://www.wbresearch.com/enterprisecollateral/dayone.aspx and management, central clearing and securities lending http://www.wbresearch.com/enterprisecollateral/daytwo.aspx are all direct consequences of the tough economic times we are living. But in the end, they all contribute to a more secure and reliable business environment, despite all the challenges they brings to small players of the market.