The Challenge of OTC Derivatives for (Luxembourg) Fund Service Providers

Derivatives are increasingly used to improve the performance in the fund industry. With the convergence of traditional and alternative investments, this trend is getting even stronger. Additionally, the local Luxembourg new SIF legislation (heavy PDF article in HedgeWeek) is further opening the door for more derivatives investment.

Aside from listed derivatives (options / futures), the ability to deliver services around OTC derivatives have emerged as a differentiating factor for Fund Service Providers always eager to attract new clients or more funds from their clients.

A growing part of the Fund Service Providers offer a range of services around OTC derivatives in Luxembourg, from handling custody and fund accounting to collateral management or independent valuation. There is room for more, despite a few hurdles to overcome.

Those hurdles are familiar challenges for the Luxembourg Funds Industry: People and Systems. Finding the profiles with, at the same time, OTC derivatives skills and in-depth knowledge of the Fund industry is even more challenging due to the product complexity which has nothing common with traditional instruments. They require systems able to capture trades, handle reconciliations, allow reporting per strategy or specific functionalities such as pricing.

From a technology point of view, the emergence of FpML as a standard for OTC derivatives should improve STP handling among Fund Administrations. Coming for the Asset Management Industry, those new systems and standards will have a significant impact on the existing IT infrastructures of Fund Service Providers. A new gap to bridge between the Fund Administrators and Asset Managers capabilities…

The growth of OTC derivatives has also driven the development of emerging services such as risk monitoring and advanced support to build structured product or trade execution services.

Luxembourg fund service providers shall keep a close eye on this market which from now on.

Yoann Jagoury, CapFields