Buy-side firms should undertake a thorough review their counterparty and trade type processes alongside collateral optimisation efforts in response to incoming regulatory changes to derivatives trading, according to a white paper from financial software provider 4sight.
Though there has been considerable publicity surrounding the need to optimise the use of collateral, which will be in significantly higher demand globally as a result of rules requiring central clearing of standardised OTC derivatives transactions, 4sight believes firms also need to re-evaluate their decision-making processes for selecting counterparty and trade type.
Before entering a derivatives trade, market participants should look to examine all the associated costs in order to make the most efficient trade possible while still meeting their investment objectives, the white paper suggested.
As well as being aware of the different costs and risks of clearing bilaterally or through a central counterparty (CCP), firms should consider collateral eligibility, haircut and concentration schedules as potential ways of reducing their expenses.
“If one counterparty will take lower quality collateral against a trade then the collateral cost will be lower than trading with someone else. Furthermore, the netting and portfolio margining benefits in terms of the wider portfolio of trades with a particular CCP or counterpart also need to be included,” the white paper said.
It added that firms should fully weigh up the pros and cons of using alternative instruments to achieve a particular outcome, noting that it can be more profitable to use a securities loan, repo or collateralise a derivatives trade in differing circumstances.
Blending together these different forms of trade optimisation is one of the major challenges now facing market participants as global rules on derivatives trading come into force. Effective optimisation strategies across all strands should help firms to support better pre-trade decision making while also complying with their regulatory obligations, according to 4sight.