He illustrated using the example of Company B and Company L. Company B borrows from Company L a portfolio of stock. In the event of a default from B, L would have to buy back the securities in the market, hence the existence of a collateral. There are two possible scenarios.
L sells the collateral portfolio and buys back the lent one.
The risk for L is the potential difference in returns between loaned and collateral securities over the buyback period. However, due to the correlation between the securities in the borrowed portfolio and in the collateral portfolio, the risk is effectively lower in the case of a stock collateral. Toubale also took participants through the construction of a collateral portfolio. From a borrowed portfolio of 300 securities, he constructed a collateral portfolio of 50 securities. To provide adequate protection, Toubale said the long and short positions of the collateral portfolio should match several criteria, including geographical match, sector match, and company size match.