According to the Bank for International Settlements (BIS), the notional amount of outstanding OTC contracts, as of June 2010, was USD582trillion, representing a gross market value of USD25trillion. The OTC market has historically been largely opaque, but things are changing. Investors and regulators alike want greater transparency.
In response to this, Citigroup last month rolled out a comprehensive OTC derivative service through its Global Transaction Services division to consolidate and simplify the post-trade execution process. But as Peter Salvage (pictured), Managing Director of Hedge Fund Services at Citi tells Hedgeweek, this was far from being a kneejerk reaction to the Dodd-Frank Act.
“The technology backing this new service has been adapted from our capital markets back office platform. We’ve been developing and investing in a core set of technologies for the last three years. This wasn’t something that happened overnight,” says Salvage. Such investment puts Citi in a strong position as it means it can react quickly to changing market regulations.
Indeed, by using an industrial-strength technology infrastructure, Citi’s OTC derivative service has stolen a march on its competitors, few of whom can claim to offer the same level of sophistication. “We’re a market leader in providing solutions to complex asset classes; this OTC service reinforces the fact,” opines Salvage.
Hedge fund managers can outsource the full lifecycle of an OTC trade to Citi. As an integrated platform it provides full connectivity to Citi’s global clearing network, model-based valuation, confirmation, settlement, collateral and margin management. Hedge funds are typically the most aggressive OTC traders and with the industry calling for central clearing, not only is this bringing, in Salvage’s view, the “start of transparency to the OTC market”, it’s also causing more fund managers to use third party administration services in response to investor demand.
“We expect this to fuel demand for operational services going forward,” says Salvage, adding that as numbers of OTC contracts being centrally cleared increase later this year, “we believe this derivative service will address that need”.
He notes that interest has already been high in Europe where fund managers are used to outsourcing services, estimating that 60 per cent of users to the new service will be hedge funds. Salvage expects roughly 25 per cent of users to be Europe-based, with upwards of 10 per cent coming from Asia “where we’ve seen particular interest in the OTC valuation offering”.
Collateral management, one of the key features of the OTC service, is another important issue at present as prime brokers and exchanges increase their margin requirements but as Salvage explains: “The comprehensive nature of the service is really its strongest feature.”
Interest from hedge funds has been “across the board” says Salvage. Several current prospects are believed to be USD10billion to USD20billion in size. “I’d say we’re more inclined towards mid- and heavyweight funds and strategic start-ups,” adds Salvage.
As to the costs of using Citi’s OTC service, it depends on the number of positions being held and trades executed by the respective fund. “Most hedge funds trade a variety of instruments alongside OTC contracts. Most want bundled support across their asset types, but the choice is theirs,” explains Salvage.
Although the service only went live last month, Salvage is bullish. “We expect to see the vast majority of our clients using this service by end-2012.”
