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Value at risk?

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News that Telekurs Financial is entering into the evaluated pricing space under its own steam with a new Fair Value Pricing service for illiquid bonds prompts us to reflect on how busy the evaluated pricing arena is getting. If, as it has long been expected to do, Bloomberg finally unveils its evaluations offering this year, that busyness will be intensified further still. Reuters and Standard & Poor’s are making concerted efforts to emulate the success of market leader Interactive Data Corp in this business, and the darling of the credit derivatives pricing world Markit Group has CMA snapping at its heels.

It is important not to over-simplify the evaluated pricing picture – there is a world of difference between an algorithmically driven engine churning out prices for illiquid straight and zero bonds based on benchmark bond prices, and an operation combining the efforts of expert financial engineers and sophisticated modelling software to price complex derivatives and structured products. That said, the lines of distinction between vanilla and exotic instrument pricing activities are blurring as, though a combination of partnerships and inhouse development, the leading players seek to make their coverage as wide as possible, in order to be in a position to value as much of a client’s portfolio as possible.

There’s no doubt that demand for evaluated prices is high, driven by the growth in alternative investment strategies and the increasing regula-tory requirement for independent valuations of portfolios – with the word “independent” being ever-more literally applied, and the viability of relying on counterparty-supplied prices being ever-more questioned. The addressable market for vendors is also wide – ranging from hedge funds to traditional investment managers to corporates to service providers like fund administrators and prime brokers.

However, increasing competition in the vendor space must be a cause for concern for those seeking to play in this game, because to play properly is no cheap undertaking. It requires continued investment in the people and technology required to create prices for an ever-increasing pool of more and more complex instruments, and in the ability to deliver them at greater frequencies and in an automated fashion, to support clients’ own STP efforts. Clients are also demanding the provision of capabilities to enable them to validate supplied prices themselves. Scale is required to be able to provide evaluated prices at a cost low enough not to make clients think they can do it themselves more cheaply, but high enough to remain profitable. And as more vendors round on the space, the competition for a share of evaluated pricing spend will clearly get tougher.

Competition is rarely a bad thing for the consumers of services of course, but given the complexity of valuing exotic instruments, it is also in the interests of funds and funds servicers to have easy access to third-party supplied, viable, comprehensive evaluated pricing sources. Of course, one important factor which could mitigate against the potentially negative effect on providers of intensified competition is the growing regulatory requirement for firms to use more than one independent source of valuations.

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