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Greenwich Report Warns of Greater Regulatory Pressures in Europe

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GREENWICH, Conn. (–A new report from Greenwich Associates Inc. analyzes the uncertain regulatory environment in Europe and the role it has played in decision-making by fixed-income investors.

The report suggests that there are two contrary trends afoot. On the one hand, new financial regulations, such as changes in pension accounting in the United Kingdom, are creating incentives for institutions to shift assets from equities into fixed income. But on the other, looming pension benefit obligations pressure institutions to increase their investment returns–a goal that appears at odds with the shift to fixed income.

Interest rates are at historic lows.

“The expected returns on core fixed-income holdings like government and investment-grade bonds fall short of the basic needs of pension funds and other institutional clients,” said Greenwich Associates consultant Andrew Awad. “As a result, European institutions are increasingly looking for alternatives with the potential for incremental returns.”

Given the contrary pressures, institutions have begun turning to complex instruments that, they hope, will improve the risk/return mix. These newly favored instruments include credit and interest-rate derivatives, collateralized debt obligations and other structured products.

The volume of credit bonds and credit derivatives below investment grade, as traded by European institutional investors, doubled from 2003 to 2004. Over the same two years, European fixed-income investors traded more than US$900 billion in covered bonds. These trends have consequences for hiring decisions. About 35% of European institutional investors plan to hire in fixed income in the coming year, the reports says.

The report also looks at the related issue of the increasing prominence of hedge fund investors in Europe. “Hedge funds are already crowding out some long-only investors for the attention and resources of fixed-income dealers,” said Greenwich Associates consultant Woody Canady, quoted in the new report. “There is certainly a concern that they might become even more valuable in the eyes of dealers under a more vigorous regulatory regime, under which hedge funds may be less constrained than other institutions.”

There are compensations for the regulatory and other pressures. Total cash compensation for European fixed-income investors (including portfolio managers, analysts, traders, treasurers and chief information officers), rose more than 10% between 2002 and 2003. The average salary reported in 2003 was US$110,000 and average bonus levels were US$85,000 for a total pay package of US$195,000, the report says.

There is also room for growth in the European market for online systems for institutional trading, including trade in fixed-income instruments. The report observes that the majority of these trades remain off line. Many of the off-line institutions are concerned with “the potential negative consequences of reducing face-to-face interactions with their dealers.” Perhaps unsurprisingly, the largest institutions are the most likely to trade electronically. The proportion of the largest institutions (those with a fixed-income trading volume of more than US$10 billion annually) that trade online was 54% in 2003, and grew to 57% this year.

Contact Bob Keane with questions or comments at: [email protected].