Buy-side institutions face significant gaps in being able to accommodate the regulatory requirements emerging in the US and Europe around counterparty credit risk and collateral management for OTC derivatives, according to a BNY Mellon survey of institutional investors released today.
Surveyed during the latter part of 2010, the analysis was conducted to show what the buy side needs to do in the face of forthcoming industry regulatory changes, which are focused on the standardization of OTC derivatives and a migration to central clearing.
The financial crisis reemphasized the importance of counterparty credit risk and the subsequent industry-led program of reform has addressed many of the shortcomings of the OTC market, says Patrick Tadie, BNY Mellons global business head for Derivatives360. While the standardization of OTC derivatives and migration to central clearing is welcomed, our current and potential clients from buy-side institutions have expressed a number of concerns that arise from this: loss of flexibility, increased cost of financing positions, management of exposure and disruption over the transition period.
Industry best practice in this area has to date been focused on banks and broker-dealers, while institutional investors have some way to go to meet the on-going regulatory requirements as set out by Dodd Frank, the European Commission and other industry efforts.
Some of the limitations of the buy-side, as set out in the research:
– 40% of institutions surveyed do not have an internal OTC derivatives pricing capability.
– Only 10% of participants report use of best practice Potential Future Exposure (PFE) calculations for counterparty credit risk measurement the 90% majority continue to use current mark to market valuation, which has no forward-looking capability.
– Over 75% of the survey group does not rehypothecate securities collateral insurance and pensions fund institutions that are able to pool collateral actively reuse securities collateral. Most asset management institutions are unable to pool collateral and see little value in reuse as a result.
– Just under 50% of survey participants have outsourced their collateral management – a further 25% have deployed vendor collateral management solutions internally, with the remainder reliant on bespoke applications.
The report can be accessed here.