Collateral Margin _ Haircut

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					                                                                            Final Draft June 2011

                                 PRACTICE PAPER



This paper seeks to outline operational best practice guidance for utilising the terms “margin” and
“haircut” in reference to collateralisation of assets on loan for securities lending transactions.

It should be noted that this paper does not seek to override any existing contractual
obligations agreed between parties in their lenidng agreements but instead outlines practical
operational guidance for Securities Lending market participants.

The industry uses the words “margin” and “haircut” interchangeably when referring to collateralisation
of the assets exchanged between the lender and the borrower in a stock loan transaction. This best
practice paper provides the context in which those terms should be used, examples on calculating
those terms and the context in which they are utilised, and references to the best practice operational
agreement documents governing collateralization. Where there is a conflict in what term to use,
margin should be priority over haircut, in terms of loan to collateral value calculation.

Margin: The difference between the value of lendable assetand the collateral pledged (e.g.,
government-issued bonds). If the collateral declines in value, additional margin will be required.

Haircut: The difference between the value of the Collateral pledged and the Lender’s valuation of the
Collateral pledged based on a risk assessment of the instrument. For example, if a lender makes a
loan equal to 90% of the dollar value of marketable securities (collateral), the difference (10%) is the
haircut. Also called haircut financing.

ALTERNATE HAIRCUT DEFINITION: The standard valuation reduction percentage (haircut) is the
amount by which the market value of the collateral is to be reduced. The lending ratio is (1 – haircut).
The lending value of an amount of the asset is the lending ratio multiplied by the market value. For
example, a 2% haircut gives a 98% lending ratio and $100 market value of that asset would have a
lending value of $98.

Margin is the level to which the value of the loan should be collateralised. Haircut typically refers to
an asset or asset class, to which the haircut or discount fact should be applied to in terms of a
reduction versus market value when it is used as collateral.

For calculations below:
     MV = market value of assets
     CV = collateral value available (market value of collateral held)
     AV = allowable loan value (given a fixed collateral value, the maximum value allowed to lend
        within agreed-upon margin levels)

M1 Calculation -- Where margin=x, then collateral required = MV * (100+x)%.
Assets are on loan for a market value of $200. If the margin is 5%, then the collateral requirements
would be $200 * (100+5)% = $210.

If a processing system calculates “here’s the value of the lent assets, request 10% incremental
collateral”, then that’s 10% margin. Take the assets and multiply times 100% plus the margin, which
gets expected collateral.
$100 of ASSETS LENT * (100+10)% = $110 EXPECTED COLLATERAL.
Comparing that $110 calc to what is held in collateral, i.e. 109.89 or 110.50….this shows either under-
or over-collateralized by -0.11 or +0.50, respectively.

M2 Calculation -- Conversely, where margin=x and collateral available is CV, then allowable loan
value AV = CV/ (100+x)%.
Collateral available is $500. If the margin is 5%, then one could lend up to the following amount:
500/(100+5)% = $476.19

If the processing system calculates ”here’s the value of the collateral, reduced to show the allowable
amount of assets you can have within that 10% tolerance”, then that’s allowable loan value.
Require collateral valued at $110 * .90909090 (or 100/(100+10)%) to get $100 value of assets that
can be lent.
Compare this allowable loan value to actual assets on loan, i.e. 99.98 or 100.04, thus, showing
under/over the allowed assets threshold by +0.02 or -0.04, respectively.

M3 Calculation – alternate system calculation method: If a processing system calculates as follows:
Value to collateralize to 100% from x% margin, CV*(100-x), where CV=collateralized value and
x=margin % (although technically, this implies x=haircut%, not margin%).

System calculates “here’s the 90% value of what is needed for collateral, and the collateral team
should gross it up to 100%”, then it would be $110 value of collateral on $100 of assets lent….the
90% value of that $110 collateral value would be $99, and one would be asking the borrower entity to
gross the collateral up to 100% (or $99 * 100/90) or $110 value. This still implies that collateral
should be 100% plus a margin of 10% (Calculation M1), but with a reversed calculation used by some
processing sytems.

H1 Calculation -- Where haircut % = x, the collateral value calculation on an asset value (MV) is CV
= MV * (100-x)%.
Asset class “equity basket” requires a haircut of 10%, and has a market value today of $600, then
CV= 600 * (100-10)% = $540.

H2 Calculation -- Conversely, where haircut % = x, and required collateral value needed is CV, then
the required market value needed of that asset class is MV = CV / (100-x)%.
Asset class “equity basket” requires a haircut of 10%. If the required collateral value needed is $500,
then the market valule of those assets would need to be 500/(100-10)%, or $555.56 to give the
necessary collateral value.

Complete Example, incorporating both Margin and Haircut into the calculation:

If one borrows an asset worth USD100 with a margin of 5% then it requires collateral to the value of
100 * (100+5)%, or $105. If no haircuts on collateral assets used, then you can pledge an asset with a
market value of $105.
If though you were use collateral assets that would be subject to an agreed haircut, based on asset
type/class, (for example main index Equity with haircut of 10%) then you would need to pledge a
market value of those assets of $105 / (100-10)%, or $116.66.

Conversion Calculation:
To convert a required collateral margin into a haircut percentage: (100 - (100/100+x)) where x is the
required margin percentage. For example a 5% margin is equivalent to a haircut of (100 - (100/105))
= 4.762%

References to margin in the legal documentation for stock lending:

In the GMSLA, the term 'Margin' references adding on to the market value. Paragraph 1.2 of the
Schedule in the GMSLA says:

'Unless otherwise agreed between the Parties, the Market Value of the Collateral delivered pursuant
to paragraph 5 by Borrower to Lender under the terms and conditions of this Agreement shall on each
Business Day represent not less than the Market Value of the Loaned Securities together with the
percentage contained in the row of the table below corresponding to the particular form of Collateral,
referred to in this Agreement as the Margin.'

 [ Table of Security / Currency descriptions and required margin percentage then follows ]

And paragraph 5.4 from the GMSLA 2010 says:

"the aggregate Market Value of the Collateral delivered to or deposited with Lender (excluding any
Equivalent Collateral repaid or delivered under paragraphs 5.4(b) or 5.5 (b) (as the case may be))
(Posted Collateral) in respect of all Loans outstanding under this Agreement shall equal the aggregate
of the Market Value of Securities equivalent to the Loaned Securities and the applicable Margin (the
Required Collateral Value) in respect of such Loans;"


In terms of how counterparties should compare collateral levels on automated comparison tools, it is
recommended that, unless otherwise bilaterally agreed, the required value plus margin should be
utilised. Any haircut on the collateral value should also be applied to the comparison.

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