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Do your findings conclude that the end investor or the people who think derivatives are just doom and gloom actually pay more fees?
That is correct. In the end the evidence we gathered suggests that derivatives are used as risk management tools and if you reduce the tools set of the risk manager you make it more expensive; either the risk manager will not use derivatives or will pass on the cost to the end investor.
Are there any surprising findings or scenarios that came up throughout your research and ‘what- if’ analysis?
The most surprising finding relates to exotic or complex instruments. At first sight one might think regulators wanting to ban exotic instruments would be a good move, but in actual fact, these instruments are really not exotic for the users but only complicated for the non-expert users. By banning exotic instruments you are reducing the risk management tool set that asset managers can use, and you must assume that the fund manager is sophisticated enough to understand these instruments and so he should be allowed to use them because they are the cost effective tools. It would be beneficial from an academic or research stand point if some countries were to ban the use of derivatives in the asset management industry and to empirically and rigorously measure the affects of this. In academic research we are only able to compare funds which are using derivatives and those which are not. The evidence is present for US funds, though it is 10 years old so not that recent however, the conclusion was there is no sign that the funds using derivatives are more risky that those which do not. This helps to dispel the notion that derivatives are used to take bets. Also, a mainstream individual or end investor is not an expert in the use of these types of instruments so would not use them to ‘take bets’ in the market despite mainstream claims that these instruments are used for this purpose. The available evidence shows that this type of use for betting is simply not happening.
With ongoing regulatory reform would you suggest to regulators that the solution is not to ban derivatives?
My point of view is very clear - banning derivatives of any sort from the asset management industry is a very bad idea. Regulators have the power to require asset managers to be more transparent. And even if you think the asset manager is not sophisticated enough to understand the consequences of the risks in their portfolios, the regulator is skilled enough to warn of the dangers. As long as they know what funds are doing that should be enough. Therefore, I am more in favour of regulation which reduces opaqueness; it doesn't need to be transparency to the final investor but to the regulator because the regulator should be able to understand when something is not right for the end investor.
Would you agree that the requirements under EMIR to report swaps for fund managers and the collateral information is a step in the right direction to give transparency to the regulators?
Yes, I think this is the way forward; all the bans were bad for the market in the end, with the short selling ban there was very strong empirical evidence and this transparency requirement though costly for asset managers, does not prevent them from carrying out their financial duties.