Collateral Optimization: Strategies for Asset Managers in Brazil Amidst Market Volatility

Many Brazilian asset managers have recently been focusing on collateral, which was brought into the spotlight due to Brazilian Real volatility in March-April. This led to margin call volumes increasing to almost double their normal levels, causing finance teams to undergo a rigorous test.

As a result of the market volatility, weaknesses in the core operational function of securing collateral to offset counterparty exposure were exposed, prompting firms to reevaluate their credit terms with current counterparties and rethink their collateral management practices.

That said, General Partners (GPs) are increasingly prioritizing collateral optimization, especially for portfolios that have an active FX hedging program, to minimize collateral drag on returns.

Traditionally, asset managers tend to prioritize operational simplicity over collateral funding efficiency, resulting in collateral strategies that hold a large portion of fund assets in cash to cover anticipated margin calls. However, holding cash collateral or buffers for potential daily margin swings comes with an opportunity cost of lost investment returns.

To combat this issue, our clients are implementing a range of tools, including improved operations and better use of technology, and engaging with new counterparties to optimize collateral.

Overall, asset managers should consider the following strategies and best practices:

Engage multiple counterparties: Having different providers will allow the manager to have a clearer view of the market offering and risk appetite while being able to compare different offerings, collateral arrangements and pricing better.?

Margin Determination tool: Our technology displays the distribution of potential margin call requirements for each hedging product. The tool will help the fund optimize the liquid funds held back. Additionally, understanding what the likelihood and levels will trigger these requirements help to negotiate better credit terms with counterparts.

Fund-level hedging is taking over deal-level hedging: Fund-level hedging will allow the fund to execute any hedging program independently of where the foreign investment is located. For counterparties to face directly LPs provide a significant improvement in terms of creditworthiness allowing the manager to efficiently access credit-intensive lines that properly optimize the usage to investor commitments unlike posting unnecessary margins and dragging the performance of the fund.?

By implementing these strategies and best practices, fund managers can minimize costs, reduce risks, and enhance overall portfolio performance.