Separately Managed Accounts in Counterparty Risk Management

Abstract

Counterparty risk management should have an integrated framework. While utilizing a separately managed account may help reduce a corporation’s concentration risk in a money market fund, it may also be an important tool to reduce enterprise level counterparty risk. A portfolio of securities not correlated with the firm’s largest credit exposures may help to diversify risk and to improve credit scores.

An Integrated Counterparty Risk Management Framework

In the years following the financial crisis of 2008, Counterparty Risk Management (CRM) took on a new level of importance among corporate treasurers. In addition to bank accounts, money market funds, and direct investments, counterparty exposures can include credit providers, swap counterparties, suppliers and customers. While CRM always has been part and parcel of risk management at financial institutions, corporate practitioners often lack either the expertise or the tools necessary to address this important subject.
In recent years, we have endeavored to help our corporate treasury readership tackle this issue. In our June 2013 newsletter, we introduced the corporate treasurers’ perspective to counterparty risk by discussing the types of susceptible transactions, new challenges in the post Lehman-bankruptcy world, and the general principles for corporate practitioners. We recommended an integrated CRM process.
In our October 2013 newsletter, we introduced the capture-analyze-manage framework to CRM which allows the typical mid-sized treasury function to capture, consolidate, and categorize various sources of risk. One may then use analytical tools to standardize and normalize risk, study aggregate risk from common obligors, conduct look-through analysis, and form critical risk assessment through a credit scoring system. We recommended managing CRM using “what-if” analysis to adjust balances in bank deposits, money market fund shares and direct investments in separately managed accounts (SMAs).

Separately Managed Accounts in Corporate CRM

As managers of separately managed liquidity portfolios, we hold the view that SMAs can be valuable tools in a firm’s overall CRM undertaking. Dating as far back as our November 2007 newsletter, we listed tailored risk management and transparency as the first two of the six advantages of SMAs. The importance of these points was highlighted during the ensuing financial crisis in 2008 and subsequently, during the extended period of sovereign debt troubles in the Eurozone.
In our October 2012 newsletter, we introduced a portfolio risk management approach to reduce corporate investors’ concentration risk in money market fund holdings. We showed that by building a separately managed portfolio alongside an existing money market fund, one may achieve a targeted portfolio weighted average maturity (WAM), reduce concentration in large financial issuers, improve the market risk profile while still achieving a yield potential comparable to the existing fund. In essence, new portfolio structures and the selection of non-correlated securities allow the combined corporate treasury portfolio to change its overall risk characteristics.
In today’s research commentary, we expand the counterparty risk basket to the enterprise level to address the firm’s overall CRM. We believe that when one applies proactive portfolio decisions to the capture-analyze-manage framework, SMAs can become prominent risk management tools in addition to their role as a sensible investment vehicle.
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