Almost 60% of the buy-side expect to see a further reduction in their over-the-counter (OTC) exposures for equity products over the next three years, according to an Acuiti report.
This follows asset managers having reduced OTC exposures in the wake of the ‘uncleared margin rules’ and other post-crisis reforms.
The report confirmed that OTC trading represents considerable operational costs, with ISDA agreements coming out on top as the greatest challenge for OTC market participants according to respondents.
The complexity and cost of trading under an ISDA agreement is a particular worry for smaller firms as the cost of signing and maintaining agreements with multiple counterparties becomes burdensome.
Will Mitting, founder of Acuiti, highlighted that this reduction in OTC exposures represents an opportunity for the market to offer listed products aimed at solving client requirements: “As asset managers continue to innovate and meet investor demands for thematic, ESG and climate investments, the sell-side is well placed to offer access to listed products that can serve these requirements.”
The OTC market has been key for the buy-side for many years, allowing them bespoke, often complex, products for their portfolio needs.
However, as strategies evolve in complexity, asset managers are seeking alternatives in their bid to gain tailored exposures to equity derivatives. So far, investors have encountered several stumbling blocks, as Acuiti explains: “Investors have faced a trilemma with no available products in the post-crisis world offering capital and margin efficiency, low trading costs and customisability.”
Nevertheless, there is a growing offering of exchange traded products in recent times, coming on the back of the rise of thematic investing and ESG, said the report.
These alternative products are aimed at “marrying the benefits of the OTC with the listed market,” specifically the customisable aspect without the associated costs (e.g. arising from ISDA agreements).
Despite ETF markets and currently available listed products meeting the demand to some extent, the Acuiti report confirmed the existence of a significant gap in the market for a customisable listed product.
Mitting addressed the changing OTC landscape and suggested that the answer could lie with custom basket forwards (CBFs): “[however] the rising costs and complexity associated with OTC derivatives has forced firms to look for listed alternatives. Our study suggests that CBFs can solve the investment trilemma for firms offering a margin efficient, customisable product with low trading costs.”
Acuiti’s ‘Solving the Investment Trilemma’ report was commissioned by Nasdaq and coincides with the launch of its custom basket forwards (CBF).
Part of the survey’s findings showed that banks see potential for CBFs to offer a new product and therefore engage new clients, bringing greater capital efficiency to the market.
In addition, for the buy-side, the top benefit of CBF’s was ‘no need for an ISDA agreement’ followed by ‘lower counterparty risk’.
Alessandro Romani, vice president, head of European derivatives at Nasdaq, said: “The Acuiti report provides great insights to the industry trends behind the increasing demand for tailored equity exposures, as well as the challenges and complexity of managing them, with the use of OTC derivatives.
“With the launch of custom basket forwards, Nasdaq is well positioned to provide asset managers and sell-side firms with an alternative solution to OTC equity swaps, based on a listed and CCP cleared derivatives contract.”