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Growing pains – The boom in buy-side derivatives usage

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19 November 2015

Investment firms are accounting for an ever-larger share of derivatives trading volumes, but a new survey shows nearly 80% have concerns from both an operations and a risk management perspective.

The newly released Asia Risk and Calypso Technology “Buy-side Derivatives survey” reveals that trading of derivatives contracts is steadily rising among investment management firms. Survey Respondents identified primarily an increase in the use of forex derivatives followed by equity and interest rate derivatives as leading this trend. The global survey was conducted over a six week period and was completed by 189 senior executives from asset management firms, insurance companies and pension funds.

The reasons for this trend include an increased familiarity with these instruments, the growing recognition they can boost returns and reduce risk, and a desire to access a wider range of assets of different types and in different geographies.

“Derivatives are now institutional investors’ bread and butter,” says Sylvain Privat, head of investment management solutions at Calypso Technology. “It has become a core function of investment firms to trade swaps and futures.”

Buy-side concerns Some 80% of respondents had either significant or modest concerns around operational and risk management with respect to OTC derivatives. The findings indicate the bulk of users are struggling to cope with derivatives trading, partly because they have not implemented the appropriate processes or systems to deal with these instruments in the new regulatory environment.

“Many buy-side firms still don’t have the infrastructure to cope with derivatives trading,” notes Privat. “A large number rely on manual processes and Excel spreadsheets to handle derivatives and therefore don’t have the integrated view of risk and end-to-end operational workflow that is required for these products which can be very complex.”

Collateral management- A key issue Collateral management was identified by 41% of respondents as having an impact on portfolio returns. “There is increasing awareness that collateral management has to be taken seriously and requires a central solution if it is to be processed efficiently,” says Privat. “Centralized inventory and optimal allocation of collateral is becoming crucial in the investment management industry.”

Underprepared for collateral management Six in ten survey respondents said they do not have real-time, intraday access to their collateral inventory, and seven in ten are not able to pre-allocate their available collateral for each margin call on an optimal basis.

In addition, almost half of the survey’s respondents are not aware of the International Organization of Securities Commissions’ (IOSCO) non-cleared margin guidelines being implemented into national regulations. “This will have major implications for both investment operations and risk management,” says Privat.