Earlier this year, the central pillar of the G20’s reform of the over-the-counter (OTC) derivatives market went into effect. While the legislation aimed to enhance financial stability and reduce bilateral exposure, it has presented new challenges and increased costs to institutional investors, including hedge funds, long-only asset managers and insurers.
In response to the 2008 financial crisis, the G20 proposed reforms to improve the transparency in the derivatives markets, mitigate systemic risk and protect against market abuse, requiring that standardized OTC derivatives use clearinghouses. After the implementation of this new rule, the Financial Stability Board (FSB) and other standard-setting bodies, including the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions, reconvened the Derivatives Assessment Team to “re-examine whether adequate incentives to clear centrally OTC derivatives are in place.” While the group found that clearing reforms appeared to create an incentive to centrally clear OTC derivatives, institutional investors have started seeing surging collateral costs.
The higher costs stemming from the new regulations affecting bilateral OTC transactions include:
- Incorporating new analytics and smarter methodologies
- Navigating compliance challenges
- Renegotiating International Swaps and Derivatives Association agreements
- Leveraging mechanisms to exchange and post increased collateral, particularly at pre-trade levels
- Losing the use of increased capital
- Eroding returns of the OTC trades for affected products, such as equity swaps, non-deliverable forwards, swaptions and more
For institutional investors with more than $59 billion of uncleared derivatives to post more in locked-up collateral for OTC derivative trades, this new regulation significantly weighs on them. To avoid the expenses involved with compliance of the new regulation, institutional investors are incentivized to use central-clearing platforms that reduce margin and operational costs and trade in listed options, including the Nasdaq-100 (NDX) and Nasdaq-100 Micro Index (XND). While the latter was designed to empower Main Street investors to harness the Nasdaq-100 through options, it also allows institutional investors to scale positions more precisely because of its smaller NDX notional value. Specifically, the Nasdaq-100 Micro Index Options represents 1/100th of the full value of the Nasdaq-100 Index.
Meanwhile, the Nasdaq-100 is one of the world’s preeminent and increasingly popular large-cap growth indexes, with exposure to leading businesses that drive the economy across a broad swath of industries, including technology, health care and consumer staples. As the Nasdaq-100 Index continues to outperform the market. As the Nasdaq-100 Index has outperformed the S&P 500 for 11 of the last 13 years, we expect more investors to flock to this index, especially as institutional investors look to mitigate the costs of the new OTC derivatives regulation.
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