State Street Corporation (NYSE: STT), one of the world’s leading
providers of financial services to institutional investors, today
announced the findings of a new Vision report entitled, “Charting New
Territory: Buy-Side Readiness for Swaps Reforms,” exploring the
readiness of institutional investors for derivatives reform. Based on
TABB Group research commissioned by State Street, the report explores
the readiness of buy-side swap market participants who collectively
represent more than $10 trillion in assets under management. The
findings illustrate the state of the industry’s readiness to implement
the key provisions of swaps reform, and describe the heavy focus firms
are placing on the clearing aspect of regulatory requirements while
struggling to adjust to new margin demands.
Key highlights from the Vision report include:
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Margin requirements are the No. 1 focus for buy-side firms when
preparing for regulatory reform
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Financial strength is the No. 1 factor when selecting a central
clearing counterparty
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A drop in liquidity was cited as the most likely unintended
consequence of regulatory reform
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More than one-third of buy-side firms do not have the high-grade
collateral required to enable swaps trading in a centrally cleared
world
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Reporting is the regulatory component for which buy-side firms feel
least prepared
The report also explores the key issues the buy-side must solve to
successfully transition to the post Dodd- Frank environment including:
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Overall buy-side readiness for derivatives reform in various
categories including registration, capital/business standards, trading
technology, selection of futures clearing merchant (FCM) or swap
execution facility (SEF) and organized trading facility (OTF), and
reporting
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Key concerns for the buy-side with respect to the pending changes
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The services and other factors that could influence decisions to
choose an FCM, SEF, and central clearing counterparty (CCP)
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Potential unintended consequences of regulatory reform
“The buy-side supports the idea of transparent markets and the entry of
new participants to compete in a market place traditionally dominated by
a few key players, and generally sees the regulations as fair and
benign, but also as more costly,” said Clifford Lewis, executive vice
president and head of State Street’s eExchange business. “However, the
process of transformation is challenging and it dominates the buy-side’s
thinking. They see a long road ahead before there will be
collateral-efficient clearing solutions, competitive electronic
execution and increased volumes that mitigate concerns about liquidity.”
Readiness
Across the five aspects of readiness for OTC reform, including
registration, capital/business standards, trading technology, selection
of FCM/SEF and reporting, not one buy-side firm stated that they were
fully ready in any of these categories. For firms who anticipate being
regulated as swap dealers/major swap participants, reporting
requirements are the area in which they feel least prepared.
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Most survey participants don’t plan to begin clearing until the
regulations are adopted, with 52 percent saying a target date would
drive them to clear sooner and 45 percent citing credit concerns as a
reason for clearing early
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Eighty-one percent of the firms we spoke with intend to continue
trading uncleared products
FCM Selection Factors
For firms looking to choose an FCM, the most important decision driver
is the capability to onboard clients and backload existing trades,
followed in importance by collateral / margin services. The study
indicates that the selection of CCPs is driven primarily by its relative
financial strength, identified by 58 percent of buy-side firms as of
“high” importance when selecting at CCP, followed by margin requirements
and netting efficiencies.
“It is fair to say that the current buy-side focus on clearing now has
eclipsed their focus on trading and connection to SEFs/OTFs at this
stage,” said Will Rhode, principal, director of Fixed Income Research at
TABB Group. “Execution is the thinner end of the wedge when it comes to
regulatory reform and the buy- side is having trouble digesting the
margin demands being placed upon them. There are also major question
marks over whether the bundling of clearing with discounted execution
services will be allowed under Dodd-Frank, which stipulates that dealers
cannot incentivize firms to clear with them by offering trading
discounts.”
Unintended Consequences
As regulatory extraterritoriality, or the way in which varying
regulations in different jurisdictions overlap, collides and goes live
at different times, the complexities of developing a compliance
framework could regionalize what has been a global marketplace. The
majority of respondents believe that the migration of bilateral OTC
markets into a central clearing counterparty paradigm will drive margin
and collateral costs significantly higher, which will in turn influence
product selection and render some exotic trade structures extinct.
Fifty-two percent of study respondents believe liquidity will dip when
the regulations are adopted, 38 percent think a collateral shortage will
result and 31 percent foresee an increase in trade and pricing errors.
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As margin calculations move from overnight to intraday, the need for
“collateral velocity” to enable trading will increase
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The forced migration of execution from phone to electronic via
SEFs/OTFs could dramatically enhance volumes in vanilla swap-products
and usher in a radically different trading model, but multiple
SEFs/OTFs, trade repositories and other systems will drive a need for
much greater connectivity and infrastructure
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Reporting requirements will add another layer of complexity to the
market
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Regulations will provide more transparency into costs throughout the
entire derivatives lifecycle – with explicit price tags attached to
each element
“The results of this survey clarify that the focus for buy-side firms
should be on the entire derivatives lifecycle, not just clearing,” said
Jeff Conway, executive vice president and head of Investment Manager
Services at State Street. “Concerns over a decline in liquidity,
collateral shortage or increased trade and pricing errors as a result of
the implementation of these regulations are front of mind; however, the
firms we surveyed vary widely in their readiness to fully implement the
changes required and in their timeline for becoming compliant. The
changes to market structure are so multi-dimensional and complex that
firms are taking longer than anticipated to prepare.”
In addition to the report released today, in September 2011 State Street
launched a Vision Report, entitled “Regulatory Reform and the
Implications for Derivatives”. State Street’s Vision Series
addresses key trends and developments impacting the financial services
industry. Previous reports have focused on regulation, emerging markets
and alternatives. To download a copy of this Vision Focus report or
others in State Street’s Vision series of in-depth reports, please visit www.statestreet.com/vision.
About State Street
State Street Corporation (NYSE: STT) is one of the world's leading
providers of financial services to institutional investors including
investment servicing, investment management and investment research and
trading. With $22.4 trillion in assets under custody and administration
and $1.9 trillion in assets under management at June 30, 2012, State
Street operates in 29 countries and more than 100 geographic markets.
For more information, visit State Street’s web site at www.statestreet.com.
*This AUM includes the assets of the SPDR Gold Trust (approx. $65.7
billion as of June 30, 2012), for which State Street Global Markets,
LLC, an affiliate of State Street Global Advisors serves as the
marketing agent.
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