Investors are responsible for understanding the risks inside the portfolios they own. Yet modern portfolio construction relies heavily on OTC instruments — credit default swaps, interest rate swaps, FX forwards, and options — that allow managers to hedge risk and adjust exposures without trading the underlying securities.
Unlike exchange-traded instruments, OTC derivatives are defined not by a standardized ticker but by their contractual terms and conditions. Terms determine the instrument’s payoff structure, risk exposures, and how it behaves in different market environments. While managers capture these details, they rarely reach investors in a usable format.
The result is a gap in infrastructure: investors responsible for overseeing portfolio risk lacking access to critical data.
OTC Derivatives: Essential Tools with Invisible Terms
OTC derivatives are not exotic instruments used only by hedge funds. They are tools used by active managers across fixed income, credit, and multi-asset strategies.
A credit portfolio manager may hedge exposure to financial institutions using credit default swaps. A global bond manager may use interest rate swaps to adjust duration. Currency forwards allow managers to hedge FX exposure without trading underlying securities.
Economic exposure of the derivative depends on the contract’s terms. A credit default swap includes: the reference entity or index, maturity date, coupon structure, payment frequency, notional amount and counterparty.
Internally, managers capture details to model risk and value positions. When portfolio holdings are delivered to clients, much of this information disappears.
Most downstream holdings files contain only a representation of the instrument – little more than a name, notional value, and market value. The contractual terms that determine the instrument’s behavior rarely travel with the position.
Without those details, independent portfolio analysis becomes extremely difficult.
Risk Without Transparency
Lack of visibility creates challenges for investors attempting to understand portfolios. A pension fund allocates capital to global credit managers. Each manager reports a holdings file that includes several CDS positions. However, the files contain only generic derivative identifiers and market values, not reference entities or indices.
When the pension fund attempts to aggregate exposures across managers, its risk system cannot determine whether CDS positions reference banks, sovereigns, or broad indices. The asset owner cannot calculate total portfolio exposure to the financial sector or run stress tests.
Infrastructure Built for Managers, Not Investors
Investment infrastructure was designed for traders and portfolio managers. Internal systems capture detailed transaction data, including the terms of OTC contracts, because managers need it to value positions and manage risk.
But the data delivered to investors is just a simplified snapshot designed for reporting. Holdings files may omit contractual details entirely. Factsheets summarize exposures. Investors can receive supplementary spreadsheets or commentary explaining portfolio positioning, but these workarounds are manual, inconsistent, and difficult to scale.
Investors then attempt independent portfolio analysis using incomplete data. Consultants, regulators, and oversight committees face the same limitations.
The Need for a Fiduciary Book of Record
The investment industry has long relied on internal books of record that track trades, positions, and valuations within asset management firms. These systems – known as Investment Books of Record – support portfolio management, trading and operations. They serve the needs of the manager.
Fiduciary oversight requires something different. Investors, consultants and regulators must be able to understand portfolio exposures independently of the manager constructing the portfolio.
A Fiduciary Book of Record (FBOR) is required: a standardized, digitized representation of a portfolio designed specifically for fiduciary oversight. It would contain the information required for downstream regulatory reporting and independent risk analysis – positions and market values along with the economic and contractual terms that determine how instruments behave.
For OTC derivatives, that includes the contractual terms and conditions that determine economic exposure. Investors, consultants, and regulators could perform consistent bottom-up portfolio analysis, aggregate exposures across managers, and run independent risk models without relying on manual explanations or delayed communications.
The objective is not to replace asset managers’ internal systems. Rather, it is to ensure that the data required for fiduciary oversight flows through the investment ecosystem in a structured, reliable, and machine-readable form.
A Necessary Step for Modern Markets
Conversations with fund selectors, institutional investors, and risk professionals reveal a common challenge: understanding complex portfolios using incomplete and inconsistent data. As portfolios become more sophisticated and derivatives play a larger role in risk management, this problem grows. Manual workarounds and document-based confirmations cannot scale to meet the transparency expectations placed on modern investors.
To keep pace with modern portfolio construction, the infrastructure supporting portfolio transparency must evolve. A Fiduciary Book of Record is a necessary step toward that future.
