Question

Critically do an Impact analysis of COVID-19 (Corona Virus) on Derivatives Investments (DI) and formulate a Business plan post COVID-19 (next 7 months) with the aim of achieving 6 main Investment objectives for DI?

Answer 1

COVID-19 will have a range of impacts on Over-the-Counter (OTC) derivative transactions. Some key impacts arising as a consequence of COVID-19 are:

• Practical effects of a lock down - We are yet to truly see how a lock down or working from home will affect derivatives , but there are number of practical considerations. For example tghe general methods of serving default notices under an International Swaps and Derivatives Assosciation (ISDA) Master Agreement, the standard document under which derivatives are traded, are mail deliveries, couriers and fascimiles. In a lock down, a counter party may not be able to locate a courier or even if they can there may be no one at the delivery location to receive the notice .
• Local business days - The majority of the obligations under the ISDA agreement need to be performed on a local business day for the relevant jurisdiction specified in the relevant transaction confirmation or separately agreed between the parties. As we saw in China, the local governments may extend public holidays so it is important to understand the jurisdictions where your local business days occur.
• Exchange Disruption - With the current market turbulence, equity derivatives are likely to be affected on price for the underlying assets or index and disruptions to the exchange ( eg suspensions or delays). Equity derivatives has a variety of disruption events which may be triggered, and is important to understand what the rights and obligations of a counter party are, including when a derivative is capable of being terminated.
• Collateral Obligations - Often a counter party will use listed assets as collateral for its margining obligations. However the market turbulence in relation to those assets may diminish their value which could in turn reduce the value of the posted collateral. A collateralised Counter party would then be able to make a collateral call, requiring additional collateral to be posted. A failure to meet collateral calls can allow counter parties to close out and terminate outstanding transactions.
• Regulatory Requirements - Following the 2008 GFC, regulatory reforms were implemented across the globe to increase the stability of the OTC derivative market. One of these mandatory initial margining is still being phased in with certain entities due to come into scope in september 2020. The documentation requirements for compliances with the initial margin regulations are quite time consuming with a need to engage with custodians, collateral managers and counterparties. Given the amount of activity in the OTC derivative market , entities may find it difficult to get traction with their custodians and counterparties on initial margining documentation if they leave it too late.

Important Investment objectives

• Safety- There is truth to the anxiom that there is no auch thing as a completely safe and secure investment. However we can get close to ultimate safety for our investment funds through the purchase of government issued securities in stable ecconomic systems or through the purchase of corporate bonds issued by large, stable compnies. Such securities are arguably the best means of preserving principal while receiving a specified rate of return.
• Income- Most investors, even the most conservative minded ones, want some level of income genreration in their portfolios, even if it is just to keep up with the economy's rate of inflation. But maximising income return can be an overarching principle for a portfolio, particularly for individuals who require a fixed some from their portfolio every month.
• Capital Growth- It is mostly assosciated with the purchase of common stock, particularly growth securities, which offer low yields but a considerable opportunity for an increase in value. Blue chip stocks can potentially offer the best of all worlds by possesing reasonable safety, modest income and potential for capital growth generated by long term increases in corporate revenues and earnings as the company matures. Common stock is rarely able to provide the safety and income generation of government bonds.
• Tax Minimisation- An investor may pursue certain investments to leverage tax minimisation as partof their investment strategy. A highly paid executive for example may seek investments with favorable tax treatment to lessen his / her overall income tax burden.
• Marketability/Liquidity- Common stock is often considered as the most liquid of all investments because it can be sold within a day or two. Bonds are also marketable, but some bonds are highly illiquid or non - tradable with a fixed term. Similarly money market instruments may only be redeemable at the precise date at which the fixed term ends. If an investor seeks liquidity money market assets and non-tradable bonds are not likely to be held in their portfolio.
• Wealth Maximisation - Shareholders wealth maximisation is another objective of investment.

These are the main 6 investment objectives for Derivative Investments. Inorder to achieve these all objectives,

• Proactively review your agreements for conseqences of market disruption
• Keep your notice information up to date
• Review your documentation as a whole
• Review business continuity plans