What are the best ways to manage conflicts of interest in collateral management?

1 Define conflicts of interest

A conflict of interest occurs when a person or an organization has multiple interests that are incompatible or contradictory, and that may influence their decisions or actions. For example, a collateral manager who works for both the borrower and the lender in a transaction may have a conflict of interest, as they may favor one party over the other or compromise the quality of the collateral. Conflicts of interest can also arise between different functions within a collateral management team, such as valuation, reporting, reconciliation, or optimization.

2 Identify potential sources of conflicts

Managing conflicts of interest in collateral management starts with identifying potential sources and scenarios that could create them. Dual agency, incentives, information, and bias are all common sources of conflicts. Dual agency occurs when a collateral manager acts on behalf of both parties in a transaction or has a personal or financial relationship with one of them. Incentives refer to when a collateral manager receives compensation or benefits based on the performance or outcome of the transaction. Information conflicts arise when a collateral manager has access to confidential or sensitive information that may affect the transaction. Lastly, bias is when a collateral manager has a preference or prejudice towards a certain party, asset, or outcome due to their own beliefs, values, or emotions.

3 Disclose and document conflicts

The second step to manage conflicts of interest in collateral management is to disclose and document them as soon as they are detected or anticipated. Disclosure means informing all the relevant parties, such as clients, counterparties, supervisors, or regulators, about the nature and extent of the conflict, and how it may affect the transaction or the service. Documentation means recording the details and evidence of the conflict, such as the date, time, persons, assets, values, and actions involved, and how the conflict was resolved or mitigated.

4 Mitigate or avoid conflicts

The third step to manage conflicts of interest in collateral management is to mitigate or avoid them, depending on the severity and impact of the conflict. Mitigation can involve separating roles and functions that may create or exacerbate the conflict, implementing clear policies and procedures for collateral management, and seeking independent verification or validation of the process. Avoidance may involve declining or withdrawing from the role or function that may generate or involve the conflict, or transferring it to another person or organization that does not have or share the conflict.