2021 has been an important year in the world of financial markets. We have seen a retail revolution, increased enthusiasm for crypto, and deep-rooted environmental, social and governance (ESG) roots in financial institutions. As we approach 2022, I think these exciting trends will likely be on the minds of many equity and alternative market investors.
As phase six of the Uncompensated Margin Rules (UMR) approaches in September 2022, another important theme will center on a greater proportion of the buy side falling within the scope of UMR and the requirement for more initial margins on a variety of instruments, including uncleared equity derivatives.
Diversification through cryptography
As 2022 approached, customers stopped asking “should I invest in crypto?” and now ask “how a lot should I invest in crypto? Particularly amid rising inflation, clients are looking to add crypto exposure to their portfolios to diversify with uncorrelated returns.
The maturing of customer understanding of cryptocurrencies and how they can be added to portfolios has led to increased adoption of crypto products, specifically regulated and centrally cleared crypto derivatives. Being able to access a new and still relatively nascent market in a reliable and known way via regulated futures and options has enabled institutional clients to get started investing and trading assets such as bitcoin and ether. . This trend is definitely one to watch in 2022.
Continued innovation of appropriately sized new micro-contracts alongside larger crypto futures contracts will also enable the deployment of traditional equity and investment strategies by risk-savvy institutional investors, while continuing to broaden the participant base by attracting more sophisticated players, active individual traders in the market.
Derivatives and ESG
The rise of ESG factors within finance has been a source of inspiration. Moving from an academic consideration to an element in many investment decisions, ESG is increasingly influencing equity, bond and commodity markets, as evidenced by the launches of more robust stock picking products. carbon indices and offsets. As sustainable investments are set to grow in 2022, the need for risk management solutions specifically tailored to ESG criteria is also growing.
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Risk management must be both simple and economical. Achieving this through derivatives based on ESG versions of existing benchmarks, such as S&P 500 ESG Index futures, allows companies to manage specific ESG-related risks in an efficient and liquid manner. S&P 500 ESG futures contracts allow funds to achieve target allocation in a more cash-efficient manner than by investing directly in the underlying stocks, potentially allowing more capital to be channeled into sustainable investments.
The use of index-based derivatives with a reliable calculation methodology will be essential to effectively hedge the different forms of ESG exposure. One such example is S&P Dow Jones Indices’ S&P 500 ESG Index, which is considered Article 8 compliant under the European Sustainable Finance Disclosure Regulation (SFDR).
UMR phase 6
A key regulation that will get more attention from the buying community in 2022 is UMR. As the threshold for the Average Aggregated Notional Amount (AANA) increases from 50 billion euros in phase 5 to 8 billion euros in phase 6, a significantly larger share of the funds will enter the scope from September 2022 and will have to constitute a margin initial on non-cleared OTC derivatives. ISDA estimates that 775 counterparties will be captured in phase 6 of the UMR, compared to 314 counterparties in phase 5.
While so far the focus has naturally been on FX and interest rate instruments, equity swaps have slipped somewhat under the UMR radar, even though OTC equities have a higher initial margin is assigned than some other asset classes. This is expected to change throughout 2022 as margin efficiency becomes increasingly important to market participants.
As such, more attention is likely to be paid to the effectiveness of the margin provided by listed and cleared equity futures, so that participants can minimize the performance drag and expense created. by increasing the initial margin requirements imposed for equity swaps not cleared under the UMR.
On the way to 2022
An important factor to note is that these three key themes are all underpinned by an ongoing challenge for the buy side, which is rising industry costs. As we approach 2022, as companies consider the application of crypto and ESG products in their portfolios while embracing regulatory changes and trying to become more profitable, the use of listed derivatives to manage risk and improve yields will become even more important.
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