Buy-side expects 20% cost hike from OTC regs

Clearing and collateralisation costs are set to increase by up to 20% as a result of regulation, according to research from consultancy Celent.

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Clearing and collateralisation costs are set to increase by up to 20% as a result of regulation, according to research from consultancy Celent.

Regulatory delays are also squeezing buy-side firms and many are worried about the potential to lose more than they gain from changes that are part of the Dodd-Frank Act and European market infrastructure regulation (EMIR).

Celent's research among buy-side businesses found that 35% believe the cost of clearing will increase by between 10-20% over the next 12 months. Another 30% are forecasting that costs will increase by up to 10%, while some expect increased clearing costs of up to 40%.

The cost of clearing is a particularly sensitive issue for buy-side firms as most are operating in a multi-asset class environment covering exchange-traded, OTC and non-cleared derivatives.

"This means that the clearable securities will have to be looked at in a clearing efficiency context in the various houses and with the various brokers, taking into account the internal efficiencies that may have been lost because some securities have been segregated - as some are clearable and others are not," explained Joséphine de Chazournes, senior analyst at Celent's securities and investments group.

Collateralisation costs are also set to increase by between 10-20% for most buy-side firms, though Chazournes said an expected saving of 10-30% gained from portfolio margining and netting across various cleared products should mean the collateral costs are cancelled out.

The regulatory process itself is also burdening the buy-side with costs, according to Celent. Delays in setting out rules and implementation guidelines mean many firms operating across the market have been committing resources to regulatory work that is still far from being completed. They have also set to see legal regulatory compliance costs rise as they begin implementing changes.

However, of particular importance for the buy-side is comparing the costs of regulation with the potential upside.

Chazournes said: "The main issue around Dodd-Frank and EMIR, but also MiFID II in Europe, is the current and future liquidity of the market. The buy-side specifically has a vested interest in decreasing counterparty risk through OTC central clearing, but it does not want the bid-offer spread to widen: they are afraid of losing more than gaining."

Consultancy TABB Group has indicated the loss of liquidity is likely to be a major issue for the buy-side in the wake of EMIR implementation, and technology implementation will be key to dealing with these changes. It expects investors will need to compete for dwindling liquidity in a reduced number of names, increasing the liquidity premium and leading to scarcity in less actively traded instruments.

TABB senior analyst Rebecca Healey said: "The ability to harness any available liquidity will require increased use of technology, irrespective of whether this is via a central limit order book, auction or RFQ process."