Buy-side institutions have very different business models to their dealing counterparties on the sell-side, and operate under a separate regulatory framework. Whilst banks will usually seek to run a balanced book of derivatives, buy-side institutions are often running highly directional portfolios as they seek to hedge the liabilities of pension fund clients or express macro-economic views. This can result in buy-side institutions being extremely sensitive to shifts in derivative pricing.
Amongst other things, sell-side dealers must constantly evaluate the cost of financing collateral, whilst also seeking to optimise their derivatives exposures to minimise the capital they must set aside under banking capital regulations. In contrast, buy-side institutions are often trading on behalf of clients that tend to be asset-rich, which means they often have the ability to source eligible non-cash collateral from amongst the assets a client already owns.
The derivatives market has been through a period of great change, and some aspects of pricing and regulation remain in flux. As markets evolve further and participants seek to converge towards best practice, buy-side institutions have their own set of priorities as they seek to adapt. Solum Financial has drawn upon its understanding of both the buy-side and sell-side industries to create this white paper.