An increasing number of fund managers are building CCP valuations into their net asset value calculations for individual funds, sources within the securities services industry told Global Custodian.
This relatively new phenomenon comes as regulations drive derivatives trades towards central clearing houses. As such, investment managers may consider basing their fund NAVs on the CCP valuation, a source within the valuations team at one fund administrator has observed. The source said one of his clients is currently setting up an Asian fund and has proposed in its offer document to use CCP valuations for OTC derivatives in the fund NAV as these valuations are a source of margin that is posted to the clearing houses.
“The thinking is that these NAVs will be what CCPs margin off, particularly in the case of OTC derivatives, said the source. This could decrease the reliance on custodians to provide these fund valuations, particularly as these fund managers seek to reduce their costs, he added.
“Fund valuations are usually provided using data from the likes of Markit or Bloomberg,” said the source. “In the OTC swaps space both counterparties have to post margins to the clearinghouse. “You have to go to a CCP and post/deliver valuation for margin. The investment manager may question why they are using valuations from a 3rd party when they already get it from the CCP and they could use this incalculating the Fund NAV.
“Funds still may not agree with the valuation provided by the CCP and may need to look at ways to challenge the valuations they provide in the same way they currently challenge valuations from other 3rd party providers.”
Funds using derivatives will usually get an independent valuation from sources such as Markit or Bloomberg. In some cases there will be two or three valuations, which will be validated and in the case where the first and second sources are within a specified tolerance of each other than the primary source will be used in the NAV calculation. If the first and second are outside the tolerance then the third sourcecould be brought into the validation. Sometimes a client may use four sources to make sure they are getting the most accurate price available, said Martin Higgs, senior vice president at State Street.
Vanilla interest rate swaps and some CDS are being cleared via a CCP going forward. The clearinghouse has a VAR based initial margin requirement to counter a default scenario. So the clearinghouse receives initial margin from each counterparty through their clearing broker. The variation margin, on the other hand, reflects the daily change in valuation. The clearinghouse then calculates a price for each OTC instrument for variation margin purposes. That price may then be used in the NAV by some fund managers.
Some managers say that if they are using that price for the variation margin then they are going to use that price in the NAV. They may also have other independent sources providing a valuation, which may be out of tolerance with the clearing house price. It comes down to the fund managers corporate governance model and its use of validation sources. We are seeing this today.
Some sophisticated fund managers are more proactive in this regard and they are moving into clearing early but even they may use external valuation providers such as Markit and Bloomberg and as well as taking in the clearinghouse price. It depends on the corporate governance of the fund manager as to how many sources get used and whether the clearinghouse price gets used in the NAV.
– Janet Du Chenne