Societe Generale: OTC derivatives and mutual funds

Societe Generale: OTC derivatives and mutual funds

A recent study by the EFAMA, the European Fund and Asset Management Association, looked at European disaffection with financial assets in general and for funds in particular. Fund units thus represent just 7% of households’ financial assets, which themselves represent less than 40% of their global assets.

Since the start of the financial crisis of 2008, household disaffection with financial securities has worsened, falling below €300bn in 2011 compared with €600bn in 2007, despite a savings rate remaining relatively high.

The EFAMA asked its members to say what factors lie behind this disaffection: mutual fund cost was mentioned by 9% of respondents, whilst market risk, poor performance, along with a more worrying lack of confidence, were mentioned by 65% of them.

Various ways to improve the situation were suggested by representatives of the European fund industry: the instigation of long-term investment incentives, better investor information regarding market mechanisms, but also by “enhancing value proposition at the manufacturing level”.

The 2,500 holders of Bernard Madoff ’s Luxembourg funds who published an open letter in the Financial Times of December 12 under the heading “Do Luxembourg SICAVs deserve their reputation as safe investment products?” draw the attention on the depositary bank controls.

It is a fact: the choice of a depositary bank is crucial, as it is this bank that is responsible for protecting the investor’s assets and for ensuring a certain level of control. There is no doubt that investors would be willing to pay more for a fund offer that stands out from the crowd through its heightened depositary control. Indeed, amongst Societe Generale Securities Services’ clients, some asset managers are demanding precisely that.

Safeguarding assets and controlling investment decision compliance is all the more complicated given that new challenges are continually emerging. An example of this are the new regulations pertaining to OTC derivatives, which are used by a growing number of portfolio managers for hedging, market exposure and alpha-generating strategy purpose. These are proving to require numerous operational changes for funds.

For socalled ‘standard’ derivatives, there is thus now the need to choose one or more clearing brokers to carry out daily collateral exchanges and to set up new processes, whether the monitoring of clearing statuses or the sourcing of new collateral requirements (initial margin in addition to variation margins).

For non-standard OTC derivatives, collateral exchanges will continue to take place bilaterally between the two counterparties, albeit with new operational constraints aimed at reducing the risks taken and with increased requirements in terms of the amount that has to be collateralised.

That’s the reason why, in the face of all of these operational changes, the enhancing value proposition put to investors shall not be limited to reducing the operational burden and costs but shall focus on organising the protection of a fund’s assets. Whatever the content of the regulatory framework, investors must be sure that the fund will operate under the control of a third party acting on behalf of their interests.

This know-how in terms of asset protection and collateral management is all the more complex given that this is a global market and a good understanding of various operational schemes is required (clearing brokers, CCPs, non-standard OTC dealers etc) within an ever-changing and unsynchronised regulatory environment.

There is no doubt that this know-how constitutes an efficient lever for enhancing the value proposition at the manufacturing level.

For further information, please write to emmanuelle.choukroun@sgss.socgen.com