UK – The UK National Association of Pension Funds (NAPF) has urged the Bank for International Settlements (BIS) and the International Organisation of Securities Commissions (IOSCO) to provide "urgent" clarification on the amount of collateral pension funds will be required to post for inflation swaps under non-cleared trades, as this could impact their hedging strategies.
Responding to a consultation paper on margin requirements for non-centrally cleared derivatives launched by the BIS-IOSCO Committee, the NAPF stressed that 57% of pension schemes in the UK used derivatives as hedging tools.
"Pension schemes' use of derivatives is generally restricted to hedging risks – as opposed to seeking returns – and long-tenure," the association said.
"Our members' derivatives holdings are across two closely related underlying markets – interest rates and inflation."
According to the committee, the consultation paper, launched in February, was the second consultative process conducted by BIS-IOSCO and represents the "near-final" policy framework establishing minimum standards for margin requirements for non-cleared derivatives trades.
In this document, the committee proposed, among other things, to set initial margin for interest rate swaps at 1-4% of notional exposure, depending on duration of the contract.
However, while the committee makes a clear distinction between credit, commodity, equity, foreign exchange/currency and interest rate derivatives, it makes no distinction for inflation swaps, which would then fall under the 'other derivatives' category.
This is where the issue lies, according to the NAPF, as the BIS-IOSCO Committee plans to set the initial margin requirements for that category at 15%.
"A key concern for pension schemes is that interest rate and inflation swaps should be treated in the same way," the association said.
"BIS-IOSCO should provide urgent clarification that the margin requirements for inflation-based derivatives will be reduced to levels similar to, and preferably identical to, those for interest rate-based derivatives."
The NAPF went on to argue that, if inflation-based derivatives were treated as an 'other' product, initial margins would then be increased by a factor of four.
"One of the UK's largest pension schemes, which represents approximately 3% of the UK pension market, estimates that it would be required to post around €1.25bn-1.7bn of initial margin if interest rate and inflation swaps were treated identically and the amounts were calculated according to the BIS/IOSCO standard approach, but as much as €2.8bn-3.4bn under the current proposal," the NAPF added, without disclosing the name of the pension funds doing the calculation.
The introduction of new rules for derivatives trades comes to meet the requirements agreed at two G20 summits held in 2009 and 2011.
In 2009, the G20 leaders initiated a reform programme to reduce the systemic risk of over-the-counter (OTC) derivatives markets, with one measure aiming to pull all derivatives contracts currently traded in OTC through central clearing.
However, mandatory clearing requirements will capture only standardised OTC derivatives, while non-standardised products, including inflation swaps, will continue to be non-centrally cleared and remain subject to bilateral counterparty risk management.
In 2011, the G20 leaders agreed to add margin requirements on non-centrally cleared derivatives to the reform programme and asked BIS-IOSCO to draft the new rules for such deals.
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