High fees and complex counterparty structures may drive institutional investors away from using derivatives new research has suggested, as regulators finally agree the terms on how to legislate practices in Europe.
Reaction to the near-collapse of the banking crisis has meant the way these instruments are used by pension schemes and other large investors has changed, investment consulting firm Towers Watson has said.
In a paper entitled ‘Is this the end of OTC derivatives for pension schemes?’ Towers Watson lays out how changes in regulation and market attitude to these investment tools will make it more costly and complicated for investors to use them.
The paper said that underlying terms in documentation had already become less attractive for investors. It said: “Flexibility over which assets can be used as eligible collateral has also reduced significantly. It appears that counterparty banks are less willing, or able, to accommodate pension schemes. This stems from a reduction in banks’ risk appetites and changes in their regulation.”
Yesterday, the European Market Infrastructure Regulation (EMIR), a new regulatory framework for over-the-counter derivatives based on criteria set by the G20, was approved by the European Parliament and the Council of the European Union, as reported in aiCIO’s sister publication The Trade.
The regulation will enable standardised derivatives to be traded on exchange-like trading venues, cleared through central counterparties (CCP) governed by strict organisational, business conduct and prudential requirements, and traded on central reporting repositories.