OTC opportunities in infrastructure investment

There’s a lot of talk right now about regulation in the OTC derivatives market – and rightly so. Both Dodd-Frank in the US and the proposed European Market Infrastructure Regulations (EMIR) in Europe carry restrictions for those trading these lucrative instruments. Many fund managers are worried about the impact that these restrictions will have on their performance, especially with so many questions around matters such as access to central counterparties unanswered. One thing that can be discussed now, though, is the infrastructure investment that will be needed in order to ensure compliance.

Which areas will require investment to survive this shakeup? Firstly buy-side firms need to examine the systems they use to process OTC derivatives. In order to comply with this wave of upcoming regulation, streamlined, reportable, flexible systems are required. Many buy-side firms, however, have an array of disparate processes, which have been expanded ad-hoc as new instruments come onto the market or new regulations take effect.

Secondly, asset managers need to focus on their staff. Increasing regulation necessitates investment in technology – and those working in the front office need to understand how this technology will impact their trading. Those implementing and operating this new technology need to understand the complex financial workings behind the exotic OTC derivatives their systems will be processing. The compliance department should be properly utilised to ensure that the whole business understands how these new regulatory pressure affects them all. Those in different parts of the organisation can still remain go-to experts in their areas, but ultimately a more holistic viewpoint will benefit the business as a whole.

Finally, and maybe most importantly of all, buy-side institutions need to ensure that they have adequate monitoring systems sitting on top of their processes. This means they can report on their compliance and make the data that can be efficiently pulled from their new streamlined back-office available to business users. It’s great to be compliant and have a fuller view of your exposure, but unless you can get at that data, you’re not fully realising its benefits.

Streamlined systems and effective reporting solutions mean business users can drill down into positions and get a more accurate view of risk. This in turn means asset managers can know exactly where they stand with relation to their trading limits at any time, and can squeeze every last penny from their investments those boundaries. They can ensure that they are compliant with regulation and reduce their operational risk. Most importantly, they will be able to trade higher volumes of lucrative exotic derivatives without compromising risk management.

Ultimately, OTC derivatives regulation is coming, ready or not. But those asset managers who see the opportunities and make wise investments will find themselves freer to do what they do best: drive performance and generate alpha.