Minimum conditions for collateralised transactions

1. There must be a contract between the ADI and the party lodging received collateral which establishes the ADI’s direct, explicit, irrevocable and unconditional recourse to the received collateral. In the case of cash collateral, this may include a contractual right of set-off on credit balances, but a common law right of set-off is insufficient on its own to satisfy this condition.
2. An ADI must take all steps necessary to obtain and maintain an enforceable security interest in the received collateral. The legal mechanism by which collateral is pledged or transferred must allow the ADI the right to liquidate or take legal possession of the received collateral in a timely manner. An ADI must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the received collateral are observed.
3. In the event of the counterparty’s default, any requirement on the ADI to serve notice on the party lodging the received collateral must not unnecessarily impede the ADI’s recourse to the received collateral.
4. Where posted or received collateral is held by a custodian or a third party, the ADI must take reasonable steps to ensure that the custodian or third party segregates the collateral from other assets.
5. Where the received collateral is lodged with an overseas branch of the ADI, the branch holding the collateral must be bound to act in accordance with the agreement between the ADI and the party lodging the received collateral.
6. Where the received collateral is lodged by a third party, that third party must indemnify or guarantee the performance of the counterparty’s obligations (or those of the party on which a claim is held) to the ADI. The ADI must ensure that the indemnity or guarantee is legally enforceable (e.g. that it will not fail for lack of consideration).
7. An ADI must ensure that sufficient resources are devoted to the orderly operation of margin agreements with OTC derivative and securities-financing counterparties, as measured by the timeliness and accuracy of its outgoing calls and response time to incoming calls. An ADI must have collateral risk management policies in place to control, monitor and report:
   1. the risk to which margin agreements expose it, such as the volatility and liquidity of the securities exchanged as collateral;
   2. the concentration risk to particular types of collateral;
   3. the re-use of collateral (both cash and non-cash) including the potential liquidity shortfalls resulting from the re-use of collateral received from counterparties; and
   4. the surrender of rights on collateral posted to counterparties.