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New Sapient study shows significant impact on buy-side portfolio returns due to post Dodd-Frank costs of clearing

Tuesday, June 04, 2013
Opalesque Industry Update — Sapient Global Markets, a division of Sapient, today announced the release of the first in-depth study into how new central clearing mandates will impact investment performance for buy-side firms. The research demonstrates significant drag on portfolio returns in the new regulatory environment. The drop in return ranges from between ~0.20% to ~0.62% for cleared hedges, up to almost 1.00% for traditional uncleared bilateral over-the-counter (OTC) trades.

The Sapient Global Markets “Cost of Clearing: A Buy-Side Investigation” study quantifies and compares the costs of a typical buy-side portfolio hedging strategy in terms of drag on portfolio returns. The study compares the overall portfolio performance of a typical fixed-income fund using four different hedging instruments over a fixed historical period: uncleared swaps subject to pre-2008 margin requirements; uncleared swaps subject to the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) guidelines for margining (effective after 2015); swaps cleared through LCH.Clearnet SwapClear; and Eris Standard swap-futures (cleared through CME).

“Because of the significant impact on performance these results demonstrate, as well as the June 10th timeline set by regulators, it is apparent that portfolio managers must examine their own hedging strategy based on expected cost of clearing with a renewed urgency,” said Ben Larah, manager, Sapient Global Markets, “Once the post-Dodd-Frank and BCBS/IOSCO recommended treatment for uncleared derivatives takes effect, using standardized and centrally cleared instruments will be the cheapest available option.”

On March 11, 2013, firms categorized as swap dealers, major swap participants and active funds were required to centrally clear several types of interest rate swaps — across four currencies — and certain credit default swap index trades. On June 10, 2013, “Category 2 Entities,” including securitization vehicles, insurers, investment funds and non-swap dealer financial institutions must begin mandatory clearing. In order to comply with complying with regulations, firms need to make informed decisions about how to invest and where to clear.

“Recent regulations mandating central clearing of OTC derivatives creates performance challenges for all investment firms and their bank counterparties alike,” said Kevin Samborn, vice president, Sapient Global Markets. “Sapient Global Markets’ experience in developing diverse OTC clearing and collateral solutions help firms effectively address these latest challenges while at the same time help to evaluate the cost of central clearing on their current strategy and develop solutions to retain maximum returns moving forward.”

The results of the study show that cumulative portfolio returns are highest when hedging is performed using uncleared swaps in a pre-2008 environment, and lowest when hedging is performed using uncleared swaps in a BCBS/IOSCO recommended environment. These results serve to show the significance of the impact of Dodd-Frank/BCBS legislation on clearing costs; once the BCBS/IOSCO recommendations take effect the use of customized, uncleared swaps will jump from being the cheapest way to the most expensive way to hedge.

Sapient Global Markets conducted this study with support from LCH Clearnet and Eris Exchange. LCH.Clearnet SwapClear provided access to the LCH.Clearnet SMART Tool and Eris Exchange provided the Initial Margin (IM) percentages for the Eris Standard contracts. Additional models were developed using the FINCAD F3 analytics package to build an internal historical value at risk model in order to calculate IM according to the BCBS/IOSCO guidelines.

The full study can be downloaded here:

Sapient Global Markets, a division of Sapient®, is a leading provider of services to today’s evolving financial and commodity markets. We offer services across Advisory, Analytics, Technology, and Process, as well as unique methodologies in program management, technology development, and process outsourcing. Sapient Global Markets operates in key financial and commodity centers worldwide, including Boston, Chicago, Houston, New York, Calgary, Toronto, London, Amsterdam, Düsseldorf, Geneva, Munich, Zurich, Frankfurt and Singapore, as well as in large technology development and operations outsourcing centers in Bangalore, Delhi, and Noida, India.

Press release


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