European pension funds warned over impact of Dodd-Frank rules
GLOBAL - Consultants have advised European pension schemes to suspend their derivatives trades with US companies until the Dodd-Frank rules is amended.
These rules stipulate that any pension scheme that enters into an agreement with a US-based organisation or any of its global subsidiaries will be required to use central clearing for derivatives trading.
While the European Parliament last month agreed to exempt pension funds from the EMIR directive on over-the-counter (OTC) derivatives for a period of three years, the Dodd-Frank regulation in the US could jeopardise part of this exemption.
The initial EMIR text said the clearing obligation should not apply to pension schemes until central counterparties develop a "suitable technical solution" for the transfer of non-cash collateral for variation margin.
Under the US directive, however, pension funds and banks that enter into a non-centrally cleared trade will have to post additional margin.
Along the same lines, if a trade is clearable, the two parties will have to enter into central clearing.
In addition, the US regulation states that every US bank, as well as its branches and/or overseas subsidiaries, is subject to Dodd-Frank rules.
European pension funds entering into swap agreements with US banks located in Europe will therefore be subject to the same central clearing requirements.
As a result, a number of consultants are now advising pension schemes in the UK and on the Continent to suspend their derivatives trades with US entities until the Dodd-Frank rules are changed.
A source from a US custodian bank in London told IPE: "The argument coming from the US regulators is that overseas branches and subsidiaries are subject to the same central clearing requirements as their US parent company due to the fact their legal entity is still based in the US.
"The grown-up approach to adopt by the US regulators would be to agree on the fact that, while a branch should still be regulated by the Dodd-Frank rules, a subsidiary should be exempted.
"In the meantime, pension funds are likely to either reduce the volume of trades with US banks or to suspend them completely - at least temporarily - in order to lower the cost related to the use of central clearing."
According to the same source, although US regulators are not yet planning to amend the rules on that particular issue, several US banks are now looking to restructure their overseas branches into foreign subsidiaries, with the view that an exemption will be granted in future.
"That way," the source said, "pension schemes will be allowed to trade with subsidiaries of US banks without necessarily having to enter into central clearing agreements and will therefore avoid any additional costs."