Mercer Sentinel has produced a report illustrating how the US Dodd-Frank Act, which became law in 2010, has the potential to “wreak havoc, both operationally and in terms of portfolio construction” for investors outside the US.

The Act, which was followed by the similar Market Infrastructure Regulation directive in Europe, demands that over the counter (OTC) derivatives be cleared by a central counterparty (CCP), such as the Chicago Mercantile Exchange. Many international OTCs are written by either US or European counterparties.

A number of standardized swap contracts written by US or European counterparties, such as interest rate swaps and some credit default swaps denominated in USD, EUR, GBP and JPY will have to be cleared through a registered CCP.

The report also predicts that provincial regulators will probably adopt concepts similar to the US in the near future.

“Australian regulators are currently considering the introduction of legislation affecting AUD-denominated OTC instruments in late 2013 or early 2014,” Mercer Sentinel says.

In order to clear OTC contracts via a CCP, institutional investors will need to either appoint and contract with a “direct clearing member” themselves or ensure that their investment managers have appointed one on their behalf. The clearer will also have to contribute to a default fund within the CCP.

Two big factors to be aware of are:

. increased collateral requirements, mandatory payment of upfront initial margin and ongoing mark-to-market paid via variation margin, and

. considerations for portfolio managers through requirements to hold eligible collateral and the potential for performance impact on client portfolios.