Keeping pace with the paper chase
Investors and market players would do well to do one thing when new financial reforms come into force – adapt quickly. A case in point is the European Market Infrastructure Regulation (EMIR) currently being drafted in Brussels.
With EMIR, one of the changes to which pension funds will have to adapt relates to the volume of agreement documents. Under the current model, pension funds are required to sign an ISDA agreement with each of their clearing members. Those clearing members are then required to sign a new set of agreement documents with each clearing house (CCP) they deal with. And because each clearing member typically has relationships with multiple CCPs to ensure different products can be cleared, the volume of necessary documentation can grow exponentially.
But Insight Asset Management believes that it has found a way to address those issues with the launch of a new legal platform for clearing. According to Jane Ivinson, general counsel at the asset manager, Insight would use the platform to execute contracts on pension funds’ behalf, while ensuring the agreements provided the requisite protection and transparency. “The only thing clients will need to worry about regarding the underlying trading documents, in the overarching clearing agreement,” she says, “will be the scope of authority they will be willing to give us.”
She goes on to say that Insight made it a condition for all its clearing members to sign the agreement if they wanted to join its panel of clients. “All clearing members sign the same identical document, so they all sign up to the same terms, except for their bespoke risk and pricing provisions,” she said.
Ivinson said the platform would also protect clients from clearing member defaults, a major concern for pension funds.
“In the case of a default, or simply because the client no longer wants to trade with a clearing member, the pension fund can easily transfer its book of business to another clearing member,” she says.
“With our agreement, portability therefore becomes a real possibility, as opposed to a theoretical possibility.”
It is easy to see why pension funds might be interested in such a platform, but what about the clearing members? Will it be a boon for them, or a threat?
The answer is probably closer to the former than the latter. The sheer volume of legal
documentation will be a problem for them as well, and the platform should help them to keep track of things while still maintaining some degree of segregation from the business in the event of a default.
Jamie Lake, principal consultant at GreySpark Partners, argues that the clearers themselves should be trying to make life easier for the end-user.
“Ultimately, it is those end-user trades that provide the reason for being for much of the financial market, so the system should not forget that the client is principal,” he says.
Still, the platform also represents something of a competitive challenge for clearing members. No doubt, it will put more pressure on them to review their fees and agree with the rules set and designed by asset managers working on pension funds’ behalf. In that sense, the legal platform could come as a breath of fresh air for pension schemes, as, to date, the pre-existing OTC clearing services have been provided by CCPs and were not originally designed with end-client interests in mind.
It remains to be seen, however, how much authority pension funds will be willing to hand over to their asset managers.
“But delegation comes with additional risk,” Lake points out. “As soon as you pass control to someone else, there is a danger that either your strategy or communication hasn’t been clear, which opens the door for things to go wrong.”
And with derivatives, as we saw in 2007-08 during the credit crunch, things can quickly go from bad to worse.