What is the history and background of your company?
KLP Kapitalforvaltning AS is the asset management subsidiary of KLP, one of Norway’s largest insurance companies, KLP provides insurance to municipalities and public sector businesses with 320 billion NOK under management. KLP is mutually owned by its customers and have over 800 employees. I have been with the asset management subsidiary for eight years as a portfolio manager where I am co-managing a global fixed income hedge fund. In our fund we concentrate in particular on the Scandinavian interest rate markets where we believe we have an edge, and with very little credit exposure overall.
Over the course of the past 12 months what do you consider to be the most significant developments in the OTC markets?
Since the credit crisis we have seen that banks are still retrenching; they have continued to cut their risk and provide less liquidity. A reduction in liquidity has resulted in larger price moves, as there are fewer risk providers to take the other side of end user demand. This gives us the opportunity to step in if prices move far from what is their long-term fair value. That also means that there is less liquidity if one wishes to exit a position, so it is a double-edged sword. One must be comfortable with carrying risk for potentially a long time. Fading liquidity can also lead to some markets disappear completely. Another development has been the European Market Infrastructure regulation (EMIR). This has had an operational impact on our business in terms of putting in place new agreements with counterparties and selecting a clearing member for OTC transactions. We have recently chosen Morgan Stanley as our clearing member. EMIR is likely to help reduce operational risk whilst the introduction of central clearing will reduce counterparty and systemic risk, although it is unclear at present as to the full benefits of central clearing.
"Quantifi has provided tools for implementing OIS discounting for front office pricing where both speed and accuracy are of essence."
What opportunities does the current environment bring to your business?
The credit crisis that precipitated presented KLP with many opportunities, as we were able to exploit the mis-pricings and dislocations in the market. Even with the current lull in the market I anticipate more volatility and consequently more opportunities going forward for KLP to capitalize on. ECB president Mario Draghi's comment that the ECB will do whatever it takes to save the Euro has been pivotal in calming the financial markets. Nevertheless, the current lull will only last as long as the ECB's plan to buy unlimited amounts of bonds is considered credible. Moreover, it may be only a question of time before the real economics will catch up with the ECB anyway. I expect we will see continued deterioration in the non-core economics in the Euro Zone and that the weakest sovereigns will suffer fresh funding crises. This is because long-term investors have, in unison, turned away from market weighted bond indexes, which previously have benefited profligate debtors. The current rally in periphery bonds has been driven by fast money, that will evaporate once the ECB removes its hand. On the other side we have sovereigns that are experiencing ever greater funding needs. Austerity measures have proven self-defeating as the private sector is not ‘crowding in’ and monetary policy is unable to provide additional stimuli.
Valuing trades using OIS discounting is now the market standard. How much of a challenge is this?
There has certainly been a change in the way we did things before the crisis given that all OTC transactions have become collateralised. This in addition to the emergence of large credit premium, even for short maturities, has meant that old basic assumptions for discounting cash flows do not hold anymore. The need for dual curves has had implications for all our systems; front office pricing models for executing trades, daily mark-to-market in trade capture system and risk measurement. Quantifi has provided tools for implementing OIS discounting for front office pricing where both speed and accuracy are of essence. In previous years, there was not a clear consensus on the methods, although it is now becoming more standardised.
"New regulation is vastly reducing the risk that banks and insurance companies can take. However, who is going to step into their place and provide capital to new and existing projects that are the building blocks in an economy?"
Looking ahead, what impact will new regulation have on the Interest Rate derivatives market?
It is difficult to predict the impact EMIR is likely to have on the OTC markets as a whole. It will most likely enhance market transparency although that’s really in the detail of the regulation. One of the uncertainties though is the amount of collateral firms have to post and also the number of clients that will have to post collateral. One question I keep asking myself in a broader context is, in the end, who ultimately is going to carry risk? New regulation is vastly reducing the risk that banks and insurance companies can take. However who is going to step into their place and provide capital to new and existing projects that are the building blocks in an economy?
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