Though pre-hedging has been lauded by some across the markets as a keyway to improve market efficiency, the buy-side continue to have reservations as to its empirical use.
Will Mitting
The mechanism allows dealers to offer tighter spreads thanks to the fact that they can better manage risk, however respondents to Acuiti’s latest report showed that asset managers as a whole believe that pre-hedging has the potential to disadvantage their trade, creating a conflict of interest between dealer and client.
In this vein, when questioned around the empirical use of pre-hedging, only 4% of the buy-side confirmed that they were confident they knew for sure when a dealer is pre-hedging.
Of course, dealers must manage risk, however 80% of asset managers believe that dealers should only hedge trades after they have been awarded the trade, found the study.
As attention ramps up, the buy-side is demonstrably taking action, confirmed Acuiti, with 55% considering implementing mechanisms to detect pre-hedging (notably 20% already have these in place).
Looking to the growing attention on the strategy, asset managers are cognisant of its real potential, however, calls for regulators to set clear rules governing pre-hedging is front of mind, found the study.
Speaking to The TRADE, Will Mitting, founder of Acuiti, explained: “Our study found that there are strong calls across European asset managers’ for global standards and greater transparency around the process of pre-hedging.
“While senior asset management executives were sympathetic to the need of dealers to hedge risk, there are very real concerns around the market impact of pre-hedging.”
Specifically, 78% responded that they “want stricter regulations and a more comprehensive framework around its usage” in order “to avoid detrimental market impacts”.
Read more: ESMA’s latest shot at ‘pre-hedging’ must now bring a clear set of rules
For now, European asset managers continue to have reservations around the practice. For example, the majority agreed that pre-hedging creates a conflict of interest between the dealer and the client (88%), and that firms should have to give consent for a dealer to pre-hedge a trade they are submitting (65%) – clearly indicating ongoing uncertainty for the time being.
Acuiti’s ‘pre-hedging in focus’ study is based on insight from senior executives (majority in senior trading roles) across 34 asset managers within Europe.