| Derivatives: a perfect match is not everything |
|
|
| 24/07/2005 | |
|
Fitting is not everything. When pondering their usage of derivatives, institutional investors should consider the risk of over the counter (OTC) products, generally perceived as more adapted to their bespoke investment needs, according to the consultancy Investit. According to its researchers, this advantage is attenuated by shortcomings in terms of OTC product pricing as well as the lack of OTC operational processes at most investment houses. In turn, final investors could be exposed to undue operational risks, OTC derivative products such as swaps are used to provide a better asset-liability matching for pension funds. The defined benefit pension fund of UK chemist Boots has just announced that it would use interest rate and inflation-linked swaps for this very reason. Moreover, inflation-linked swaps combined to conventional bonds are also seen as a way to remedy to the short supply of indexed bonds since it allows for the construction of "synthetic" index-linked bonds. Opacity Yet, Investit found that institutional investors could be better off by sticking to exchange-traded derivative products, easier to use from an investment manager's perspective and far more transparent than OTC products. The consultancy, which interviewed the CIOs of various investment companies, found that many managers still lack the operational process for providing a transparent reporting of their OTC transactions to their clients, among which pension funds, as well as to the regulator. "Normally all OTC business (e.g. swaps, forward foreign exchange) is traded on a net price basis, with no separate breakdown of any commission cost", points out Catherine Doherty, Principal at Investit. "Commercial negotiation is centred entirely on the trade price to be agreed between the two counterparties and there is no solid agreement on the pricing of OTC derivatives between fund managers and brokers", she adds. High price Investit also makes a special reference to the "slippage" effect – the difference between the trade price expected and that actually achieved in derivatives, which is especially difficult to measure in OTC contracts, making the pricing of those derivatives even more opaque. "If I were a fund manager I would never trade exotic derivatives because whatever view a manager is trying to express can almost always be reflected more cheaply with vanilla products", stated to Investit a derivative specialist who took part in the survey. The consultancy concludes by saying that investors would benefit from exchange-traded derivatives thanks to their absence of operational risk and hidden pricing costs. However, while exchange-traded products may be easier to explain to a client for a fund manager, those instruments continue to face serious market hurdles. "They compete with each other to attract business through the launch of new products; many of which never build enough liquidity to attract potential users on a large scale", highlights Investit. Julien Laplante |
|
Articles of the same Topic : Derivatives |
|
© Copyright 2008 bfinance. This document is for your personal non-commercial use. Any further copying, reproduction, distribution is strictly prohibited. To obtain permission please contact This e-mail address is being protected from spam bots, you need JavaScript enabled to view it