Moody's: OTC regulations could lead to riskier investments
27 August 2012 London
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Funds could invest more heavily in collateral-eligible liquid, high-quality government securities when new OTC derivatives regulations take hold worldwide.
New OTC derivatives regulations are being implemented in Europe and the US, as well as other jurisdictions, in a bid to mitigate the risks that are associated with OTC transactions.
In May, regulators met in Toronto to discuss the implementation of regulations and iron out technical issues. Representatives of regulators from key markets, such as Europe, the US, Singapore, Hong Kong and Brazil, attended the meeting.
High on the agenda were pre- and post-trade transparency, margin for uncleared derivatives, coordination of clearing mandates, access to data in trade repositories, and cross border clearing house crisis management.
A joint statement from the participating regulators said: “The participants welcomed the opportunity for continued discussion and sharing of information on implementation of OTC derivatives reform, with a view to further align regulatory requirements where possible.”
In a new report, Moody's said that while increased collateral requirements for derivatives transactions will lead to a sounder credit environment for the market as a whole, they could force some funds into riskier investments.
It said: “Lower yields on government securities resulting from their increased demand from regulatory requirements may lead to a shift in bond and money market fund allocations into riskier, lower credit-quality investments to seek higher yields.”
It added that when regulations that require central clearing for standardised derivatives and global standards on margins for unclear trades come into effect before the end of 2012, they will cause demand for government securities to increase and exert downward pressure on yields, “which will lower returns for the funds that are mandated to invest in these securities”.
“Moody believes that the new regulations will exacerbate conditions that are already exerting pressure on yields, such as (i) government benchmark yields have fallen, some to negative territory, with a flight to quality; (ii) the supply of higher-rated investment-grade corporate, supranational and agency bonds remains limited; and (iii) the use of higher credit-quality corporate and agency bonds as eligible collateral is beginning to be seen in the market, although the level of usage remains low.”
New OTC derivatives regulations are being implemented in Europe and the US, as well as other jurisdictions, in a bid to mitigate the risks that are associated with OTC transactions.
In May, regulators met in Toronto to discuss the implementation of regulations and iron out technical issues. Representatives of regulators from key markets, such as Europe, the US, Singapore, Hong Kong and Brazil, attended the meeting.
High on the agenda were pre- and post-trade transparency, margin for uncleared derivatives, coordination of clearing mandates, access to data in trade repositories, and cross border clearing house crisis management.
A joint statement from the participating regulators said: “The participants welcomed the opportunity for continued discussion and sharing of information on implementation of OTC derivatives reform, with a view to further align regulatory requirements where possible.”
In a new report, Moody's said that while increased collateral requirements for derivatives transactions will lead to a sounder credit environment for the market as a whole, they could force some funds into riskier investments.
It said: “Lower yields on government securities resulting from their increased demand from regulatory requirements may lead to a shift in bond and money market fund allocations into riskier, lower credit-quality investments to seek higher yields.”
It added that when regulations that require central clearing for standardised derivatives and global standards on margins for unclear trades come into effect before the end of 2012, they will cause demand for government securities to increase and exert downward pressure on yields, “which will lower returns for the funds that are mandated to invest in these securities”.
“Moody believes that the new regulations will exacerbate conditions that are already exerting pressure on yields, such as (i) government benchmark yields have fallen, some to negative territory, with a flight to quality; (ii) the supply of higher-rated investment-grade corporate, supranational and agency bonds remains limited; and (iii) the use of higher credit-quality corporate and agency bonds as eligible collateral is beginning to be seen in the market, although the level of usage remains low.”
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