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CCPs, asset managers oppose rehypothecation of securities

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GLOBAL – Central clearing houses (CCPs) have no interest in rehypothecating the non-cash margin calls posted by pension funds for derivatives trades, a number of market participants, including CCPs themselves, have claimed.

Speaking with IPE about the need of CCPs to rehypothecate the cash and non-cash collateral posted by their clients in derivatives transactions, Renaud Huck, head of UK buy-side relations at Eurex Clearing in London, said that, in the worst-case scenario, if a clearing member were to default, Eurex would offer the possibility to port the positions and the collaterals of its clients.

"We recognise sometimes the necessity for collateral transformation for financial needs," he said, "but the industry has to come up with better solutions than that, with solutions that are not to the detriment of the buy side."

The rehypothecation methods aim to provide counterparties with a broader array of collateral availability and the ability to enter into a wider breadth of trade types.

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Those methods are traditionally used in over-the-counter (OTC) trades and benefit the end user by reducing the cost of derivative trades.

However, it also creates additional counterparty credit risk since the end user may not receive the collateral back if the dealer defaults.

Responding to a consultation paper on the draft technical standards for the regulation of OTC derivatives, CCPs and trade repositories, a number of pension funds across Europe urged the European Securities and Markets Authority (ESMA) to rethink the way CCPs rehypothecate non-cash collateral.

In the Netherlands, the Dutch Pension Federation warned that, by not restricting rehypothecation, the non-cash collateral could be seen as being part of the bankruptcy estate of the CCP if it goes bankrupt.

The BT Pension Scheme in the UK echoed those concerns and urged CCPs to place non-cash securities posted by pension funds in fully segregated accounts instead.

"Such non-cash collateral should be held with the custodian in the name of the posting entity [the pension fund], with a security interest provided by the CCP," the Federation said.

Nadine Chakar, global head of derivatives at BNY Mellon's global collateral services business in New York, argued that market players were increasingly keen on segregated accounts.

"As part of our own risk mitigation practices, we actually started to put in place segregated accounts for hedge funds back in 2008 before Lehman collapsed," she said.

"So when hedge funds started to be a little bit concerned about their prime brokers, we noticed that increasingly they were depositing their initial margins with us in segregated accounts that have control agreements."

And as Dodd Frank and EMIR progress, Chakar stressed that asset managers had grown much more sophisticated in their set up to provide the same type of products to pension funds.

However, Chakar acknowledged that the uptake in the US had been slower than in Europe, where pension funds are seen as taking a more "proactive" approach.

"We have seen a lot more enquiries from European schemes, not only for segregated accounts but clients are interested getting their documentation in place," she said.

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