Regulatory reforms facing the over-the-counter (OTC) derivatives market will likely cause a surge in demand for liquid, high-quality government securities, which could, in turn, push fund managers into riskier securities in search of yield, says a new report from Moody’s Investors Service.
In its report, the rating agency says that new regulations for the OTC derivatives markets will exacerbate conditions that are already exerting pressure on government bond yields, such as: the flight to quality, and the limited supply of other sorts investment-grade bonds. New rules that require central clearing for standardized derivatives and global standards on margins for uncleared trades will help push down yields on government securities even further, it suggests.
“As the new regulations come into effect by the end of 2012, the demand for government securities will increase and exert downwards pressure on yields, which will lower returns for the funds that are mandated to invest in these securities,” it says.
While Moody believes that the new regulations will result in a sounder credit environment for the market as a whole. At the same time, it says that lower yields on government securities may push bond and money market funds into riskier, lower credit-quality investments to seek higher yields.