GLOBAL – Sapient Global Markets has warned that new central clearing requirements for over-the-counter (OTC) derivatives trades could slice between 0.20% and 0.62% off portfolio returns for buy-side players, including pension funds.
In a report entitled "Cost of clearing: A buy-side investigation", Sapient calculated and compared the costs a typical buy-side portfolio-hedging strategy would entail under new mandatory central clearing requirements.
According to the report, the buy side would incur a drag on its portfolio of between 0.20% and 0.62% for cleared hedges and nearly 1% for uncleared bilateral OTC transactions.
Sapient based its calculations on the overall portfolio performance of a typical fixed income fund using four different hedging instruments.
The firm used uncleared swaps subject to pre-2008 margin requirements; uncleared swaps subject to the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) guidelines, which will come into force after 2015; swaps cleared through LCH.Clearnet SwapClear; and Eris Standard swap futures, which are cleared through CME.
The research showed that cumulative portfolio returns were highest when hedging was performed using uncleared swaps in a pre-2008 environment, but lowest when hedging was performed using uncleared swaps in a BCBS/IOSCO recommended environment.
Ben Larah, manager at Sapient, said the "significant impact" on performance showed that portfolio managers must examine their own hedging strategies based on the expected cost of clearing with "renewed urgency".
"Once the post-Dodd-Frank and BCBS/IOSCO recommended treatment for uncleared derivatives takes effect, using standardised and centrally cleared instruments will be the cheapest available option," he said.
The new guidelines for non-cleared bilateral OTC derivatives trades currently being drafted by the BIS-IOSCO Committee are to meet the requirements agreed at the G20 summits in 2011.
After the G20 leaders initiated a reform programme in 2009 to reduce the systemic risk of OTC derivatives markets – with one measure aiming to pull all derivatives contracts currently traded in OTC through central clearing – new measures were adopted two years later.
In 2011, G20 leaders agreed to add margin requirements on non-centrally cleared derivatives to the reform programme and asked the BIS-IOSCO to draft the new rules for such deals.
The new measures came in response to the fact that mandatory clearing requirements would capture only standardised OTC derivatives, while non-standardised products, including inflation swaps, would continue to be non-centrally cleared and remain subject to bilateral counterparty risk management.