OTC regulations could lead to riskier investments
28 August 2012
As new over-the-counter (OTC) derivatives regulations are being implemented worldwide in a bid to mitigate the risks associated with OTC transactions, a new environment is emerging that poses new types of risks to fund managers: One in which the low returns offered by safe haven assets force investors to move deeper into higher risk, higher return assets.
In a new report, Moody's said that increased collateral requirements for derivatives transactions will lead to a sounder credit environment for the market as a whole, but they could force some funds into riskier investments.
“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 said.
It notes 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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