EUROPE - Having to post initial margin in OTC derivatives trades would increase costs for pension schemes and could even increase risk for non-systemic institutions such as IORPs, the European Federation for Retirement Provision (EFRP) has claimed.
Responding to a joint discussion paper on the development of regulatory technical standards on capital and collateral levels for counterparties, the EFRP argued that the EMIR Directive fails to establish whether and to what extent pension schemes should exchange initial margins (IM) with their counterparties.
The EFRP added that, more generally, the EMIR text fails to clarify between initial margins - currently not used by pension funds, as they are considered highly creditworthy by counterparties - and variation margins - which are already used by IORPs.
Even though pension funds have been temporarily exempted from the EMIR Directive and the requirement to clear derivatives trades centrally, European 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 - unnecessary under a bilaterally cleared transaction.
The EFRP therefore fears that the outcome of initial margin calculations will be "very high", as most pension schemes arrangements "do not have expedient and low-cost access to liquidity sources".
It added: "The derivatives transacted by pension schemes arrangements are typically long-dated and one-directional, meaning very little offsetting options exist in the portfolio that would reduce the overall amount."
"Given the large one-sided exposure, IORPs are disadvantaged in management of initial margin in comparison to derivatives dealers: these generally see more trading flow with offsets and have a broader base of counterparties to allow for lower margin requirements."
The EFRP concluded that, while mandatory high levels of initial margin may oblige pension schemes arrangements to put large cash reserves aside to meet margin rules, it would also drive the cost of OTC derivatives up, making it more expensive for pension schemes to "insulate" themselves from risk.