In an era when counterparty risk has come to the fore of concerns for super funds, custodians may well represent the greatest potential danger, according to Brett Elvish. Elvish, principal of Financial ViewPoint, an independent consultancy specialising in backoffice advice, and a former managing director of Intech Investment Consulting, said the fact that most custodians were usually involved in cash management, foreign exchange and securities lending, alongside custody, meant that there were various risks to the fund.

These were exacerbated, he said, by the custodian often adopting the position of principal rather than agency within the trades. (Super funds often prefer a principal arrangement, however, because they may be better known to the client, for example, when the contract is with an Australian bank.) Chairing a plenary panel session at the conference – entitled ‘Derivatives and Counterparty Risk: What Happens When the Dust Settles’ – Elvish questioned whether most super funds could detail where their major counterparty risks lay.

Andrew Skinner, executive director of JP Morgan Credit and Rates Markets, said documentation was a key to assessing counterparty risk. He said that in 2007, in global markets, there was only one credit ‘event’. In 2008 there were 11 credit events and some ‘near misses’, including Bear Sterns, while in 2009 to date there had been 12 defaults in publicly traded markets. “There has been an increase in tail-risk events – things that are not supposed to happen, in a statistical sense,” he said.

“All bets are off in respect that no institution
can be deemed to be too large to fail nor free of any credit risk.” But this
did not mean that funds should pull back from using derivatives, which played
an important role in financial markets. Derivatives were also an important tool
for funds managers. Sidney Chong, head of fixed interest, cash and currency in
BT Financial Group’s investment solutions group, said that a lot more resources
were needed in dealing with investment banks in the past 18 months.

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