AIA looks to address rising hedging challenges

The insurer's head of investment solutions explains why upcoming changes to rules for using derivatives led to it implement a new collateral reporting solution.
AIA looks to address rising hedging challenges

As if Covid-19 wasn't enough of a challenge, insurance firms will also have to grapple with multiple rule changes on the use of derivatives contracts in the coming years that will impact how it hedges interest rate and currency fluctuations.

Hong Kong-based insurer AIA has responded by signing up for a service provided by BNP Paribas Securities Services that measures and monitors counterparty and liquidity risks arising from derivative exposures. 

“Increasing regulation of derivatives, such as the introduction of mandatory clearing and the associated increased collateral requirements ... present the greatest challenge to AIA’s use and management approach for derivatives,” Trevor Persaud, the insurer's head of investment solutions, told AsianInvestor

Persaud didn't specify the reasons for choosing BNP Paribas over other market offerings. IHS Markit, for example, has a derivatives collateral management solution, CloudMargin.

     Trevor Persaud, AIA

Insurance companies have traditionally used derivative instruments to manage and mitigate a variety of risks. However, more are employing them now not only to hedge against increased market volatility amid the pandemic, but also for income generation.


Moreover, several Asian countries are progressively implementing new rules on using over-the-counter (OTC) derivatives contracts.  

Hong Kong’s Securities and Futures Commission, for example, will phase in the initial margin (IM) requirements from September 1 next year. IM refers to collateral held to protect a counterparty to an uncleared derivatives contract from potential credit and operating losses.

Such policies are driven by supranational regulatory bodies – the Basel Committee on Banking Supervision and the International Organization of Securities Commissions – pushing to reduce systemic risks and counterparty risks involved in trading OTC derivatives. OTC derivatives include instruments commonly used by insurers, such as foreign exchange forwards or swaps

Asian insurers are also facing the planned transition from the London interbank offered rate (Libor) to alternative reference rates and the ensuing changes will impact their investments and the use of derivatives. The most referenced short-term interest rate in the world, it is set to be replaced at the end of 2021.

Meanwhile, some countries in the region, including Hong Kong and Japan, are introducing their own local-currency alternative reference rates for short-term lending, so the valuations of assets tied to these rates will change, leading to adjustments in collateral requirements. 

All these regulatory changes mean insurers will be met with liquidity challenges due to new collateral requirements. They will have to do many more calculations in respect of the collateral needed for managing their OTC derivatives contracts. And for firms with operations in multiple jurisdictions, the tasks will be even more complex. 

Managing derivatives portfolios in different jurisdictions across Asia Pacific requires a robust risk management and governance process, noted Mark Konyn, group chief investment officer of AIA, in a joint press release with BNP Paribas on July 30 about the selection of the new solution. 


And insurance companies in Asia in general are making more use of derivatives contracts for hedging and other purposes, and that is only likely to continue as the region's markets mature. Paul Carrett, group CIO of Hong Kong-based FWD, told AsianInvestor this year that he had “strong conviction” regarding the use of derivatives. 

Moreover, insurers in Hong Kong, Japan and Korea are pursuing more active, non-traditional approaches, such as the use of swaps, swaptions and reinsurance transactions, to reduce duration gaps, according to rating agency Moody’s. 

Philippe Tassin,
BNP Paribas

When it comes to using derivatives, efficient sourcing of collateral remains “the greatest encumbrance”, said Persaud, so tools that support the asset owner manage and optimise collateral requirements are critical.

The tool, which BNP Paribas rolled out in June, enables asset owners to monitor counterparty credit risks and liquidity risks in their derivatives portfolios and reduce the reporting time for such activity, said Philippe Tassin, the bank's head of asset managers and asset owners for Asia Pacific. 

Persaud noted: “The worst-case collateral requirement calculation [WCCR] methodology that BNP Paribas calculates for AIA was developed a number of years ago and is used to establish the minimum collateral needed to support derivative transactions."

BNP Paribas Securities Services has been providing the service on an interim platform since 2017, said Tassin. 


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