EUROPE - Having to post large amounts of cash as collateral in derivatives trades would have a direct and profound impact on pension funds' returns, industry bodies have warned.
A number of experts, responding to a consultation paper on the EMIR Directive's draft technical standards, argued that pension funds were low-risk counterparties in over-the-counter (OTC) derivatives trades and should therefore be exempt from having to post cash as collateral.
Question number 50 of the consultation - launched by the European Securities and Markets Authority (ESMA) last month - asked market participants whether a minimum percentage of collateral received from a clearing member should be provided in the form of cash.
In its response, the Association of British Insurers (ABI), said: "Whilst we agree it is sensible for a small amount of cash to be required as collateral, we would also point out that funds often already post excess margin.
"To increase beyond that would not be good - there are obviously not unlimited resources, and if margin requirements are too high, the cost consequences would not be just the actually monetary amount payable, but also the lack of returns from assets tied up in margin requirements."
The ABI also pointed out that, in terms of credit ratings, all counterparties are typically treated the same in the counterparty model.
"Pension funds and other real money investors present lower risk, and there would be a significant impact on investment returns if they were forced to move too far into cash and near-cash assets," it said.
The ABI also insisted that a clear distinction needed to be made between initial margin and variation margin.
The UK's Investment Management Association echoed those thoughts, arguing that cash plus a considered list of high-quality sovereign bonds would be appropriate for variation margin purposes.
However, with regards to initial margin, the association claimed there was no need for cash at all.
It said the list of eligible assets should include corporate bonds of high quality, in addition to the assets mentioned by ESMA.
Even though pension funds have been temporarily exempted from the EMIR Directive and the need to clear derivatives trades centrally, European pension schemes will be subject to central clearing as soon as the industry has developed the "appropriate technical solutions" for the provision of non-cash collateral.
Under the central clearing system, a counterparty would be likely to require pension funds to post initial margin in the form of gilts or cash - which was not necessary under a bilaterally cleared transaction.
In addition, the EMIR Directive currently states that pension funds will also have to post variation margin in the form of cash.
According to asset manager BlackRock, a cash requirement, if passed onto the end investor, would require a very significant proportion of investment portfolios to raise cash, resulting in lower returns, "and hence savings and pensions, for European citizens".