BNY Mellon sees opportunity in OTC derivatives reform

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Sovereign wealth funds (SWFs) and many asset owners are among those set to benefit in the securities lending and repo markets, following recent regulatory changes in the over-the-counter (OTC) derivatives markets, claims a white paper from BNY Mellon and the Judge Business School of the University of Cambridge.

The paper, OTC Derivatives Reform: Putting asset owners and sovereign wealth funds in the driver’s seat, points to recent regulatory changes such as Basel III that have placed increasing restrictions on financial institutions, resulting in potential opportunities for SWFs, which are exempt from many of these new restrictions.

“While SWFs traditionally have taken a cautious approach to investing, they are grappling with a low-interest rate environment as they seek liquid investing opportunities,” said Hani Kublai, BNY Mellon’s head of investment services for Europe, the Middle East and Africa (EMEA).

“This is especially true for commodity-dependent sovereigns. However there is an investment opportunity for sovereign wealth funds because their own bonds are exactly the type of high quality liquid assets (HQLA) that are sought in the securities lending and repo markets.”

In addition, the significantly increased demand for collateral generated by OTC derivatives markets reform creates further opportunities for SWFs in the repo markets, where many buy-side market participants seek collateral transformation transactions in order to submit eligible collateral to clearing houses.

While the reforms are limiting the risk appetites of banks and curtailing the activities of other financial institutions, they exempted the SWFs from certain restrictions, according to the report. For example, the European Market Infrastructure Regulation (EMIR) requires market participants to centrally clear OTC derivatives. SWFs are exempt from this limitation and can continue to use bilateral clearing and are also exempted from costly capital requirements.

“While the SWFs could have growing opportunities and a competitive advantage in certain types of transactions, SWF fund managers will need to be aware of a variety of dynamics in the marketplace,” Kublai said. “In particular they will need to be aware of the capital positions and other risks faced by their counterparties.”

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