FINCAD – Vancouver – A recent capital markets survey conducted by FINCAD, the leading provider of sophisticated valuation and risk analytics, found 92% of financial institutions’ derivatives usage will either increase or stay the same in 2017. FINCAD surveyed more than 230 buy and sell side institutions from throughout the world.
In their search for better returns in a low interest rate environment, firms are employing more sophisticated investment strategies, and expanding into new asset classes, currencies and instrument types, including exotic derivatives. John Hull, PhD, of the Joseph L. Rotman School of Management, agreed stating, “Some market participants are finding success in enhancing yield through the use of derivatives and sophisticated trading strategies.”
The upward trend in the use of derivatives was also confirmed by the recent Bank for International Settlements Central Bank Triennial Survey. The survey, which close to 1,300 global financial institutions participated in, found that the daily average turnover of foreign exchange and interest rate derivatives traded worldwide – on exchanges and OTC – rose from $10.5 trillion in April 2013 to $11.3 trillion in April 2016.
However, oftentimes firms are held back by legacy systems that prevent them from implementing more complex strategies involving derivatives such as futures, options, swaps, swaptions and hybrids/structured products. Evidence of this trend was seen in FINCAD’s survey results. For those financial institutions considering more sophisticated investment strategies, 57% were either unsure or certain that their existing systems are unable to handle such changes. As a result, many would need to invest heavily in overhauling or replacing their valuation and risk systems. This may be at least part of the reason why 67% of firms polled indicated that they will need to increase their investment in technology over the next year.
“The current reality is that small-scale tools are too basic, and in-house developed legacy systems are too rigid to support the complexity, nuances and demands of derivatives trading today,” commented Matt Streeter, Capital Markets Strategist at FINCAD. “What financial institutions need is a comprehensive and flexible valuation and risk solution that enables them to move quickly on market opportunities.”
FINCAD’s report also indicated increased regulatory requirements surrounding derivatives is another large concern for today’s financial institutions. According to the study, greater derivatives regulation means that more capital, additional reporting and greater cost are all required to maintain the same business. These factors are making it harder for firms to manage risk and generate the kind of returns they need to remain competitive.
Hull’s colleague, quantitative finance thought leader, Alan White, PhD, offered his perspective on what regulations mean for derivatives trading today. “Continuously evolving regulatory and capital requirements are squeezing derivatives businesses everywhere. The one bright spot is in equity trades where futures forward and swaps are used as leverage tools to amplify returns,” stated White.
On the topic of regulation, Hull also weighed in. “Regulation has had a huge effect on the OTC derivatives market and significant resources have been devoted to quantifying counterparty credit risk. Regulators seem determined to make the OTC market similar to the exchange traded market and they are having some success,” commented Hull.
For a visual breakdown of FINCAD’s survey findings, view the Capital Markets Survey Infographic, and for extended survey commentary from Hull and White, check out our related blog post.
About FINCAD FINCAD is the leading provider of sophisticated valuation and risk analytics for multi-asset derivative and fixed income portfolios. FINCAD helps over 1,000 global financial institutions enhance investment returns, manage risk, reduce costs, comply with regulations, and provide confidence to investors and shareholders. Clients include leading asset managers, hedge funds, insurance companies, pensions, banks and auditors. For more information, visit www.fincad.com.