Wednesday, May 29, 2013 8:54:35 AM

Investit warns on ‘short-term fixes’ on collateral obligations

Investment managers risk falling foul of collateral rules stemming from the Dodd-Frank Act and the European market infrastructure regulation (EMIR), as many rely on short-term fixes, according to investment consultancy Investit.

To reduce counterparty risk linked to OTC derivatives trades, regulators are enforcing central clearing and margin requirements, limiting eligible collateral to only very liquid and low risk assets.

However, many fund managers with low volumes of OTC derivatives in their portfolios are potentially using less regulated securities in order to achieve new risk hedging techniques, such as swap-based futures.

While such methods could avoid regulatory costs and operational headaches, Investit says that it is only a matter of time before more regulation blocks off these techniques.

Sarah-Jane Dennis, consultant at Investit, said investment managers should not come to rely on these short-term fixes and should instead look to ensure they have proper collateral arrangements in place.

"Investment managers in general tend to be quite conservative users of OTC derivatives and so many of them have not planned what to do when things go wrong," says Dennis.

"They need to have a backup plan, because when you hit problems with your margin calls jumping suddenly and you face the risk of running out of cash, you won't have time to sit down and discuss what to do. You don't want go running to your custodian asking for money without a plan in place."

Despite the potential for problems, Investit says it was surprised at how few investment managers were expecting changes to collateralisation rules to have a significant impact on their firm.

Just 27% expect the change to have a significant impact, while 19% believe the effects will only be limited and 27% see no impact, according to research by Investit.

Dennis believes investment managers with OTC derivatives in their portfolios should be bracing for the impact of the changes, though she believes many are suffering from "regulatory fatigue" stemming from the major increase in regulation seen in recent years.