Firms seeking independent prices for OTC derivatives have a potential new partner in the shape of Vancouver-headquartered OTC Valuations Limited (OTC Val).
Founded this year and comprising a team of people with backgrounds in mathematical modeling, valuation system implementation, training, proprietary trading support and spreadsheet consulting services in the OTC derivatives area, OTC Val has launched a service for primary, secondary and tertiary valuations for both vanilla and exotic derivative instruments. The vendor is also targeting white-label relationships with data vendors and fund administrators. In its first month of operation, it has already signed up some small hedge fund clients.
This may seem like an increasingly crowded marketplace on the supply side, with niche players like Markit Group and CMA vying for business with the established providers of fixed income evaluations such as Interactive Data, Standard & Poor’s and Reuters, which are all expanding their services to cover derivatives. However, demand for such services is also growing, as traditional asset managers invest more widely in derivatives, fund administrators report that the volumes of derivative investments they must administer are starting to rival if not exceed volumes of cash instruments, and regulatory scrutiny and of course the fall-out of the credit crunch intensify pressure on firms to make use of independent pricing sources.
According to Bob Sangha, one of the founders of OTC Val, the vendor aims “to cater to a unique, niche market around structured products”. “The major data vendors have certainly made great strides in improving their infrastructure to address the need for evaluated pricing driven by regulatory demands such as Sarbanes-Oxley and FAS 157,” he says. “But we still see a significant gap in the area of illiquid structured products, due to the unique nature of the products. So our aim is to tap into that requirement and provide services either directly to clients or to partner with the data vendors to feed them our model-driven prices. These vendors are creating huge databases of evaluated prices; the more pricing data they can compile, the easier it is to use matrix approaches to create evaluated prices.”
OTC Val’s white-labelled service is relevant not only for data vendors but for fund administrators and custodians, Sangha adds. “OTC Val is committed to working with various groups to meet independent valuations needs – especially in providing greater transparency for exotic derivatives,” he says. “To cater for the growing demand for independent pricing from asset managers, hedge funds and investment vehicles, some of the fund administrators and custodians are undertaking an expansion of their capabilities, but they know there is no quick fix,” he continues. “A number are re-architecting their models to support the expansion of their clients’ derivatives operations over the next five to 10 years, but they’re taking a long-term view and know it will take time to implement. We could also work with these types of firms to bridge the gap until their new capabilities are ready. In the case of the fund administrators we would either feed our pricing data directly to their clients, or we would feed our data to them and they would forward it on to their clients.”
At the heart of the OTC Val service is a system that automates the typically manual process of pricing derivatives, Sangha says. “With more than 20 years of experience in front office financial analytics design and implementation, proprietary trading support, software and valuation and risk management, OTC Val delivers an automated solution based on carefully selected market data, calibrated models and proven valuation methodologies,” he contends. “Using a system to price vanilla and exotic derivatives minimises the labour-intensive processes required to price structured products, enabling us to achieve economies of scale.”
There are three key ingredients for a successful platform to support structured products pricing, reckons Sangha: “The right set of financial analytics, the right set of financial market data and the right team of professionals. We have found that no one source of analytics/market data can support all the models you need, so we have brought together a collection of different models covering equity, fixed income, foreign exchange, structured products, hybrids and commodities.”
OTC Val says its system uses mark-to-model and mark-to-market valuation methodologies, combining analytics with various market data sources to generate scheduled reports. For derivatives that can be replicated with vanilla, liquidly-traded instruments and valued in a model-independent way, the focus is on mark-to-market valuation using market data from brokers and data vendors. For exotic and structured products with limited price discovery and imperfect replication, OTC Val offers offer mark-to-model valuation based on calibration of industry standard models.