Summary Despite uncertainty in the financial markets most buy-side respondents anticipate an overall increase in OTC derivatives usage for 2010. While most are aware of proposed and pending regulations many anticipate a minimal to moderate impact on their business. The main challenge areas that firms are facing center around independent pricing and valuations as well as accurate risk assessment.
The usage of OTC derivatives amongst Buy-side participants is strong and expected to increase in 2010 Nearly all the respondents surveyed use OTC derivatives or bonds in their portfolios. 27% of them are prolific users, whose portfolios contain 75% or more of these instruments, 40% are heavy to medium users and 29% are moderate users. An overwhelming majority of respondents expect usage to either increase or remain the same in 2010. EMEA region respondents have slightly more derivatives heavy portfolios than their AMAPAC counterparties and at the same time expect usage to increase significantly more. 52% of EMEA based professionals anticipate an increase in usage compared to 38% of AMAPAC based respondents. It is interesting to note that despite the tumultuous times in the financial marketplace buy-side institutions remain strong and avid users of derivative instruments.
The usage of OTC derivatives amongst Buy-side participants is strong and expected to increase in 2010 Percentage of Portfolio in OTC derivatives (All Buy-side respondents) (n=357) 4% 29% 0% - 25% 25% - 50% 50% - 75% 75% - 100% Other 27% 16% 24%
Most heavily traded asset classes are Interest Rates, Fixed Income, and Equity – these are also the areas of predicted growth for 2010 When asked about the types of instruments most heavily traded, the most popular mentioned were Interest Rates, Fixed Income, Equity, Foreign Exchange, and Credit. These same heavily traded instruments are expected to be growth areas for 2010 as a part of front office expansion. Hedge Funds as a group are heavily trading more complex instruments such as Credit and Hybrids versus Asset Managers. Asset Managers anticipate more trading in Fixed-Income then Hedge Funds as a part of front office expansion. EMEA notably trades heavily in Interest Rates, but less so in Equities than their AMAPAC counterparties. These are also the same areas of anticipated growth for 2010 trading desk expansion.
Most Heavily Traded Derivatives by Asset Class (Percentage selected “applicable”) (n=357) Energy Hybrids Commodities Credit Foreign Exchange Equity Fixed Income Interest Rate 2% 8% 15% 38% 40% 47% 58% 60% Most heavily traded asset classes are Interest Rates, Fixed Income, and Equity – these are also the areas of predicted growth for 2010
The majority of buy-side professionals rely on counterparty pricing and spreadsheets to value their OTC derivatives Respondents indicate the most popular pricing sources for OTC derivatives are: (51%) counterparty pricing, (49%) spreadsheets, and (46%) in-house systems. While many respondents are using at least two pricing sources there is a surprising (38%) of respondents who have indicated they use just one source of pricing for their OTC derivatives pricing. When we look deeper into those who reported using only one source of pricing, we see the most popular being in-house systems (37%) and counterparty pricing (31%). Hedge Funds appear to rely more on spreadsheets and off-the-shelf software (as a pricing source) than Asset Managers. The AMAPAC region rely less on in-house systems versus the respondents from EMEA.
The majority of buy-side professionals rely on counterparty pricing and spreadsheets to value their OTC derivatives Types of Pricing Sources Currently in Use (% selected “applicable”) (n=337) In-house systems Off-the-shelf software Spreadsheets Counterparty pricing 46% 31% 49% 51%
Trading systems and risk management systems are the two most popular in-house systems used by the buy-side 72% of respondents have indicated they have in-house trading systems (TS) and 71% have in-house risk management systems (RMS) in place. Interesting to note that more Hedge Funds have RMS and TS in-house then Asset Managers, 82% of Hedge Funds indicated they have RMS compared to 68% of Asset Managers. Regional differences show that EMEA’s use of Treasury Management Systems is more common than in AMAPAC.
Trading systems and risk management systems are the two most popular in-house systems used by the buy-side Types of Systems Currently Used in-House (Percentage responded “Yes”) (n=337) Liability Asset Management System Treasury Management System Risk Management System Trading System 47% 71% 72% 48%
Transparent, documented models are the most important element of an OTC derivatives pricing solution 46% of respondents ranked transparent, documented models as very important elements of a derivatives pricing system. Other important elements of an OTC pricing solutions also include ease of use and comprehensive coverage. For both Hedge Funds and Asset Managers current analytics is also a very important element of a pricing solution. EMEA and AMAPAC concerns regarding pricing solutions are for the most part aligned. AMAPAC respondents place a higher importance on staying current with their analytics solutions. 41% in AMAPAC believe this to be extremely important while only 16% in EMEA thought the same.
Transparent, documented models are the most important element of an OTC derivatives pricing solution Important Elements of a Pricing Solution (Percentage responded “very important”) (n=295) Strong support services Cost effective Risk management capabilities Current analytics Comprehensive coverage Ease of use Transparent, documented models 25% 28% 30% 36% 38% 40% 46%
While pending regulations is expected to pose a minimal to moderate impact on business many anticipate growth in the area of risk management Majority of respondents expect a minimal to moderate impact of pending regulations on their business, and at the same time anticipate risk management to be a growth area for 2010. Of the buy-side respondents 21% of Hedge Funds anticipate no impact as they felt well prepared for any upcoming regulations and a full 80% see risk management as the greatest growth area. Asset Managers feel less prepared and expect compliance to also be a growth area for the middle office. Of the two regions AMAPAC respondents felt more prepared and only 5% expect regulations to pose a major impact where significant changes will be needed to accommodate these changes.
While pending regulations is expected to pose a minimal to moderate impact on business many anticipate growth in the area of risk management Impact of Upcoming Regulations on Business (All respondents) (n=295) 10% 15% No impact Minimal impact Moderate impact Major impact 32% 43%
The main challenges that firms are facing center around independent pricing and valuations as well as accurate risk assessment Overall 34% of respondents felt that independent pricing and valuation is their biggest challenge and 32% indicated accurate risk assessment as an area of concern. There are no notable differences in this area between Hedge Funds and Asset Managers. In addition to the main challenges, many EMEA professionals have also indicated that regulatory compliance as a challenge area. This is consistent with the EMEA’s overall anticipation that pending regulations will require some significant changes to be made.
The main challenges that firms are facing center around independent pricing and valuations as well as accurate risk assessment Challenges Currently Faced WRT Derivatives (Percentage ranked “biggest challenge”) (n=295) 7% Independent pricing/valuation Accurate risk assessment Hedge effectiveness Regulatory compliance Transparency in financial reporting 9% 34% 18% 32%
Methodology FINCAD conducted an online survey of global buy-side professionals. The survey took place March 25 – April 13, 2010. Respondents are a mix of front office (41%), middle office (22%), and back office (15%) professional from 30 different countries. Regional breakdown of completed survey results include Americas (67%), Europe (25%), and Asia Pacific (9%).
About FINCAD Founded in 1990, FINCAD provides software and services supporting the valuation and risk management of cross-asset class derivatives and fixed income securities to asset management firms, hedge funds, banks, corporate treasuries, auditors, and governments. FINCAD is the industry standard for financial analytics used by more than 4,000 organizations in over 80 countries. Over 70 FINCAD Alliance Partners embed FINCAD analytics within their solutions. FINCAD provides sales and client services from Dublin, Ireland and Vancouver, Canada.