The effective management of regulatory risk can be equally important than the counterparty risk when trading in emerging markets, according to panellists at the MN's 24th Annual Beneficial Owners' International Securities Finance and Collateral Management conference.
Panelists unanimously agreed on the significance of conducting risk and return analysis.
To be able to insulate yourself from counterparty risk, it is necessary to consider all the possible aspects that can go wrong in a securities lending programme, according to a panellist.
A fellow speaker suggested that the first step should be to understand what was the client's risk profile, especially when engaging in emerging markets.
Asian markets, both emerging and established, such as Taiwan and Japan, are very lucrative but without knowing all the regulations on lending, investors could face penalties easily.
If industry participants fail to comply with the expectations of the local regulators in these markets, it can result in some mandatory buyings and penalties, a speaker added, which is not something European investors will be used to, although the Central Securities Depository Regulation is on its way.
Another panellist suggested that it is a safe path to “hold back a certain percentage of the assets”.
This means a certain amount of yield will be sacrificed to preserve the portfolio's safety.
During the panel, the major fallout that a default could cause was discussed with speculative costs running into the billions of dollars.
The best preparations for this scenario are the constant monitoring of the counterparties and understanding all the exposures you have got through your counterparty, according to a panellist.
The speaker representing an agent lender added that his bank has a default management process and that default simulations were carried out a couple of times a year.
Another panellist representing the banking side outlined that it was crucial to have someone in the system “who knows what to do when there is a default”.
