Hedge funds still struggling to get to grips with CCP requirements

InvestorsLegalOperational RiskRegulation
21 Nov, 2011

Many hedge funds are still grappling with the collateral management requirements associated with mandatory over-the-counter (OTC) derivatives clearing.

A report, published by research firm Finadium and sponsored by technology vendor Omgeo, revealed market participants are concerned about the complexities of collateral management. The survey also predictably said this would inevitably lead to funds outsourcing these functionalities to third party vendors.

Central counterparty (CCP) clearing houses can demand margin on a daily or even intra-daily basis. This will be a challenge for funds given that most do not have the internal infrastructure to cope with these new changes. A recent survey by technology firm Algorithmics highlighted half of all hedge funds made only weekly margin calls.

“There is a mixed picture in terms of how well prepared hedge funds are for the changes in the OTC derivatives market. Certainly, it is on the radar of most funds, and some medium and large funds have already started to implement system upgrades. Others, particularly the smaller funds, are planning for implementation on a three to six month rolling basis until there is further clarification around what the final rules around clearing will be,” said Martin Loxley, director of collateral management at Omgeo.

“Daily or intra-day margin calls are a concern for many hedge funds but in general, they are taking a pragmatic and practical approach to the changes and are working out which systems, processes and clearing counterparts are best suited to their business needs,” he added.

Some fund managers have urged regulators and CCPs to let them to use equities and mutual fund units as eligible collateral. However, this is unlikely to happen given the stringent risk management procedures employed by CCPs and the concentration of risk they will be taking on.

“The larger funds operating across many different asset classes are generally further along in preparing for the changes in OTC derivatives trading, partly because they are incorporating this into wider system upgrades,” stressed Loxley.

There is also debate as to whether the rules will be pushed back beyond their December 2011 deadline. Several commentators have said a delay is looking increasingly likely following Congressional proposals to reduce the Commodity Futures Trading Commission’s (CFTC’S) budget.

“It is always a possibility that regulatory timetables are delayed. From our clients’ perspective, they want to see the right balance between the products that are cleared bilaterally and those that become eligible for central clearing. Whilst greater clarity around the final rules is welcome for planning purposes, at the same time, clients want to see a thoughtful and considered decision making process,” said Loxley.