Buy-side institutions face significant gaps in being able to accommodate the derivatives regulatory requirements emerging in Europe and the US, a BNY Mellon survey of institutional investors has revealed.

Surveyed during late 2010, the Mitigating Collateral Damage: Current Themes in Managing and Mitigating Counterparty Credit Risk for OTC [over the counter] Derivatives research established how institutions are addressing the challenges of counterparty credit risk and collateral management for OTC derivatives.

According to BNY Mellon, industry best practice in this area has been focused on banks and broker dealers, while institutional investors have some way to go to meet the ongoing regulatory requirements as set out by Dodd Frank, the European Commission and other industry efforts.

The research found that 40% of institutions surveyed do not have an internal OTC derivatives pricing capability and only 10% of participants report use of best practice Potential Future Exposure (PFE) calculations for counterparty credit risk measurement, with the 90% majority continuing to use current mark to market valuation that has no forward looking capability.

It also showed that over 75% of the survey group does not rehypothecate securities collateral and fewer than 50% of participants have outsourced their collateral management.

Commenting on the report, Patrick Tadie, BNY Mellon’s global business head for Derivatives360 said: “The financial crisis re-emphasised the importance of counterparty credit risk and the subsequent industry-led program of reform has addressed many of the shortcomings of the OTC market.

“While the standardisation of OTC derivatives and migration to central clearing is welcomed, our current and potential clients from buy-side institutions have expressed a number of concerns that arise from this: loss of flexibility, increased cost of financing positions, management of exposure and disruption over the transition period.”

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