THE IMPACT OF REGULATORY REFORM ON DERIVATIVES PORTFOLIO VALUATIONS IN EUROPE

The financial crisis highlighted the need to increase regulation across the financial services industry. Failures in finance were at the heart of the crisis as complex chains of debt between counterparties were vulnerable to just one link breaking. Credit derivatives, such as Credit Default Swaps (CDS) that were meant to spread the risk turned out to concentrate it. Failures to adequately rate and understand the risks in structured financial products led investors to think that they were buying triple-A tranches, when in fact they were not. Such factors and others put derivative instruments further under the spotlight.

Derivatives are feared by many as obscure instruments that were partly responsible for the financial crisis. Many people often fail to understand derivatives and how they actually work. This in itself creates the fear that these ‘beasts’ cannot be tamed or managed. There have been numerous well-documented cases of mis-selling derivative products across the globe that rattled investors further. Other scandals, such as LIBOR-fixing, created more uncertainly in volatile markets and did not help the derivatives cause. Regulation is expected to curb such practices and has sought to address the issue of transparency within the derivatives markets in order to provide better protection to investors.

Apr-Jun 2015 Issue

FTI Consulting