Supporting Derivatives
| Date: | July 2005 |
| Author: | Ashley Payn |
Asset managers want to extend the range of derivatives they use. But there is great variation in current experience. Are managers running before they can walk? They should consider the cost of implementing derivative projects and the level of support and experience they need to establish before they can move further into the realm of exchange traded and more exotic, over the counter (OTC) derivatives.
Asset managers need to consider some key areas before they increase their use of derivatives - especially the business impact. There is generally poor management of the overall cost of using derivatives - the request to use these instruments is driven by individual portfolio managers, rarely by the client or overall business. What are the benefits of using derivatives and how much is it going to cost? Particular consideration should be given to the expertise companies need to establish before using derivatives. Some asset managers consider very low levels of training for support staff and portfolio managers sufficient. But this can lead to costly errors.
This report sets out current best practice to address the issues raised - founded on the experience (successes and failures) of asset managers, brokers and vendors. It's practical advice for asset managers and project managers faced with extending the use of derivatives in client portfolios.
This research shares the experience of asset managers, derivative brokers, system vendors and trade associations. The report was co-authored with the specialist Derivatives and Securities Consultancy.
Table of contents
| Management Summary | 1 | |||
| 1.0 | Introduction | 3 | ||
| 1.1 | Scope | 4 | ||
| 1.2 | Methodology | 5 | ||
| 1.3 | Why use derivatives | 6 | ||
| 1.4 | Investment products and derivatives | 8 | ||
| 2.0 | Derivatives in Investment Management | 9 | ||
| 2.1 | Futures | 11 | ||
| 2.2 | Forwards | 19 | ||
| 2.3 | Options | 22 | ||
| 2.4 | Swaps | 29 | ||
| 2.5 | Contracts for difference (CFDs) | 35 | ||
| 2.6 | Other things which are not derivatives | 36 | ||
| 2.7 | Other derivatives on the horizon | 38 | ||
| 3.0 | Business Areas Affected | 41 | ||
| 3.1 | Pricing and valuation | 42 | ||
| 3.2 | Order management and trading | 45 | ||
| 3.3 | Compliance | 48 | ||
| 3.4 | ETD settlement and margining | 50 | ||
| 3.5 | OTC settlement and term sheets | 53 | ||
| 3.6 | A technical note on FIX and FpML | 57 | ||
| 3.7 | Collateral and cash management | 58 | ||
| 3.8 | Performance measurement | 60 | ||
| 3.9 | Ongoing maintenance | 61 | ||
| 4.0 | Business Issues | 63 | ||
| 4.1 | Business approval methods | 64 | ||
| 4.2 | Managing costs | 70 | ||
| 4.3 | Derivatives and outsourcing | 75 | ||
| 4.4 | Exchange traded or OTC? | 76 | ||
| 5.0 | Suppliers Mentioned | 77 | ||
| 5.1 | Pricing and modelling | 78 | ||
| 5.2 | Market-related | 80 | ||
| 5.3 | Middle and back office | 81 | ||
| 6.0 | Conclusions - Planning for the Future | 83 | ||
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