OTC Derivatives Evaluated
| Date: | November 2008 | |
| Author: | Sarah-Jane Dennis | |
Since 2007 the financial world has been experiencing unprecedented events and investment confidence has plummeted across the globe. Derivatives have once again hit the headlines, specifically the Over The Counter (OTC) derivative instrument Credit Default Swaps (CDS). They have been widely denounced by the media and particularly in US congressional hearings. Surely then, to the question of whether OTC derivatives “are worth it”, the answer must be “no”.
But then again, maybe not...
In this report we consider the recent market events and highlight that the actual villain of the piece was the structured debt instrument Collateralised Debt Obligations (CDOs); not CDS. Based on figures from the Bank of International Settlements, OTC market volumes have been rapidly building in notional value and market value, since 2004. And although the growth in CDS volumes dipped in 2007, all other OTC types kept on going. Therefore the market wide view is that OTCs are very much here to stay.
From the point of view of the fund manager, they are essential to a number of fundamental investment strategies. In this report, these strategies are considered from the perspective of the asset manager’s clients and from the perspective of the asset manager themselves.
Table of contents
| Management Summary | 1 | ||
| 1.0 | Introduction | 3 | |
| 1.1 | The shark factor | 4 | |
| 1.2 | Scope | 5 | |
| 1.3 | Background | 6 | |
| 2.0 | Balancing the Drivers of OTC Derivatives | 11 | |
| 2.1 | Arguments for using OTC derivatives | 12 | |
| 2.2 | Arguments against using OTC derivatives | 14 | |
| 2.3 | Governance | 16 | |
| 3.0 | Investment Strategies Using OTC Derivatives | 19 | |
| 3.1 | Investment manager objectives | 20 | |
| 4.0 | Assessing the Benefits of OTC Derivatives | 23 | |
| 4.1 | Performance assessment | 24 | |
| 4.2 | Assessing the arguments for OTC derivatives | 27 | |
| 5.0 | An Overview of Costs | 31 | |
| 5.1 | Assessing the arguments against OTC derivatives | 32 | |
| 5.2 | Initial set-up costs | 33 | |
| 5.3 | Ongoing maintenance costs | 35 | |
| 5.4 | Operational impact | 37 | |
| 6.0 | Assessing the Costs of OTC Derivatives | 43 | |
| 6.1 | Budget based cost model | 44 | |
| 6.2 | Task based cost model | 47 | |
| 7.0 | Outsourcing OTC Derivatives | 53 | |
| 7.1 | Outsourcing | 54 | |
| 7.2 | Component outsourcing | 57 | |
| 8.0 | Conclusion | 59 | |
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