What is your reaction to the changing regulatory landscape? How will it impact the buy-side?
The regulatory landscape still proves to be one of the biggest challenges to the buy-side industry and will do so for the next 12-18 months. The RTS is expected to be published in the next couple of months which will add some certainly for the first time on the timelines going forward. Once clients and firms decide which of their portfolios fall into which category, the real challenge will be to engineer a solution for collateral management more advanced than what has typically been employed in the bilateral world. The collateral management sector is in a constant state of change and the ability to find an optimal solution, whether it’s through the bilateral repo market, agency stock lending or a combination of both will occupy the minds of many asset managers over the next year. System requirements are also significant. The ability of managers to consider the impact of clearing swaps in terms of initial margin based on existing positions and also to determine what collateral is available and its value, is not something that many vendors currently offer solutions for.
Over the course of the past 12 months what do you consider to be the most significant development in the OTC markets?
One of the most significant developments over the last 12 months has been the change in the way OTC derivatives are discounted. The ‘Sonia Flat’ approach that has prevailed since the financial crisis is being replaced unofficially by ‘Sonia plus a spread’, this spread being a factor of increased squeezes in the repo market and further tightening of bank balance sheets. This has led to concerns whereby the valuation of swaps on books and the realisable value is diverging. Re-couponing of swap positions has also become more of a challenge to the buy-side following the further balance sheet restrictions that brokers now face with the transaction costs for such trades encompassing many more variables.
"The continual regulation that the sell-side faces in terms of their balance sheets suggests
the ability for them to competitively price bilateral trades will erode over time and that
is something that market participants are already beginning to see"
Looking ahead, what market developments do you anticipate and how do you ensure you are adequately prepared to address those developments?
EMIR clearing will impact the market considerably going forward and the market between cleared and non-cleared swaps will continue to bifurcate. The ability to clear swaps both operationally and efficiently from a collateral management perspective is crucial for firms to prepare themselves for the landscape ahead. The communication of the estimated costs of clearing to clients continues to prove difficult given the protracted timelines involved.
What is the single biggest risk-based issue that will affect asset management firms in 2015?
One of the biggest risks in 2015 that firms face is not progressing themselves far enough internally in terms of adapting to the cleared world. The changes required are significant and are not be underestimated particularly if a firm employs third party administrators for their back office operations. Furthermore this is also a large operational undertaking required by clearing brokers to on-board clients and those that leave this late may potentially find themselves waiting in line and coming very close to deadlines. Although the timelines at this point may appear to be far into the distance, it is likely that there will be benefits in clearing before this becomes mandatory.
The continual regulation that the sell-side faces in terms of their balance sheets suggests the ability for them to competitively price bilateral trades will erode over time and that is something that market participants are already beginning to see. Although still in the consultation stage, margin on uncleared trades is expected to be introduced at some stage down the line. How this will actually work at a practical level raises many questions but when this does come into force, margin requirements are expected to be punitive relative to cleared trades.
What implication does the requirement of Forward FX clearing have on the industry?
The proposed timeline for FX forwards is beyond that of OTC swaps. The way this market operates is different to that of OTC swaps which in turn is making the design of a cleared FX market more challenging for the regulators. In terms of the concerns voiced about the industry post 2008, it seems to have been disproportionally quiet for FX trades. In many buy-side firms, FX does not fall under an ISDA framework and is not collateralised. The exposure that exists between themselves and sell-side firms is significant and in some cases dwarfs OTC swap exposure. This was highlighted in the bankruptcy of Lehman where a large proportion of the contracts that had to be settled by the administrators involved forward FX. Centrally clearing FX represents a further area of considerable change to buy-side firms to contend with in the years ahead. One of the issues here is FX applies to equity portfolios considerably more than OTC swaps. These portfolios hold minimal amounts of cash and really do not have anything in the way of collateral that can be posted against these positions which is further consideration for the regulators.
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