The ongoing transfer of financial risk from banks to the buy-side is positive, because the likes of asset managers generally have stronger governance than their sell-side peers, argued Bradley Ziff, senior risk adviser at technology provider Misys.
Following the introduction of a raft of legislation in the wake of the financial crisis curtailing banks’ ability to engage in speculative investing, those institutions have been offloading assets to be snapped up by buy-side firms.
The process has already occurred in the US, where banks shed $500 billion worth of tradable assets from their balance sheets between the second quarter of 2012 and the fourth quarter of 2013, and is ongoing in Europe. But it has only just begun in Asia, noted Ziff.
The transfer of risk matters, because buy-side entities are not as systemically important as banks, hence if there is a problem, the effects would be more limited, he argued. Also, that shift diversifies risk because the buy-side has more participants, with differing approaches to managing risk.
Ziff said investors in Asia will have a broader set of opportunities because of this risk-transfer process – in areas such as real estate, peer-to-peer lending, commodities and infrastructure.
“This is a great opportunity to diversify how risk is taken,” he argued. “The concept of taking risk in the system is going to change, and that’s important for investors from wholesale institutions, family offices, pension funds and insurers, along with those in the retail sector, which wants access to alternatives.”
But the process of asset transfer will look different in Asia, because regulations are being implemented differently and there is level of systemic risk is lower.
“In big money centres like New York and London, regulation was close to one-size-fits-all,” said Ziff. “But in Asia, most lending is domestic; the banks are not running nearly as large or levered a lending portfolio and the risk is therefore lessened.”
Some have raised concerns that the process of risk transfer would lead to the buy-side being blamed should a liquidity event result in large investor losses.
Yet while a crisis is possible in the retail markets, said Ziff, he thinks it unlikely – and even if one were to occur, the consequences would not pose systemic risk. Such a crisis could come in the form of either a pension fund or insurance company suffering meaningful losses and investors losing confidence in their providers and withdrawing their assets quickly.
Investors might also lose confidence if alternative investments transferred to the buy-side perform badly. But this scenario is largely hypothetical, Ziff said. Like most institutional investors, pension funds run very diversified portfolios and allocate only a small percentage of their assets to alternative strategies.
One transfer of risk in the market he sees as less positive is that of over-the-counter (OTC) derivatives to central counterparty clearing.
G20 finance ministers and central banks view the mandatory central clearing, trading and reporting of OTC transactions as a solution to the risks brought on by structural deficiencies and opaqueness of the OTC universe.
But Ziff said: “I don’t know whether the risk-offset process is correct. What do we do with a default? Does it get picked up in the market itself and absorbed – the concept right now – or do we have to have some capital set aside as a buffer?”
Michael Syn, head of derivatives at Singapore Exchange, has admitted that it’s possible for central clearing counterparties (CCPs) to be engineered badly with regard to achieving to systemic risk reduction. CCPs may not ultimately succeed in eliminating counterparty risks, but could merely shift the risks into these new institutions.
Ziff said: “The regulators said we can sleep better at night because they have so de-risked the banks that there won’t be another systemic issue. You can get to the point that you can manage those risks down, but you can’t make them go away.”