EUROPE - A higher "confidence level" under the European Market Infrastructure Regulation (EMIR) could force pension funds to increase their margin calls for cleared OTC derivatives trades, while the European Securities and Markets Authority (ESMA) should stop central clearing houses from reinvesting the non-cash collateral posted by pension schemes, pensions representatives have claimed.
Responding to ESMA's consultation paper on the draft technical standards for the regulation on OTC derivatives, CCPs and trade repositories, a number of pensions bodies in Europe warned about the risk of increasing the "confidence interval" for the initial margin calculation.
The Dutch Pension Federation said: "The consultation paper suggests to set confidence levels for the initial margins calculation for OTC derivatives at 99.5%. This is simply too high."
In its consultation paper, ESMA said it was required by Brussels to define the "appropriate" percentage above the minimum 99% confidence interval - which refers to the level of confidence the CCP should have to determine the amount of additional margin it might need to collect for cleared OTC trades.
A confidence interval was already set in a previous consultation paper on margin requirements for non-centrally cleared derivatives launched by the International Organization of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS).
The two groups set the interval at 99%.
The Dutch Pension Federation went on to say it was not very "logical" to make this distinction between cleared and non-cleared derivatives and warned against the potential impact such a confidence level could have on pension schemes.
"We have been informed that a confidence level of 99.5% could result in an initial margin increase of almost 23% for an end user," it said.
"In effect, through these confidence interval levels, a redefinition of margin and default fund split respectively is achieved. At the same time, it is not necessarily the case that a higher confidence level leads to more safety."
In the UK, the Investment Management Association (IMA) also argued that it was "inconsistent" with the CPSS-IOSCO Principles and the standards established in the US under Dodd Frank based on CPSS-IOSCO.
"Material differences in initial margin calculations between the US and Europe will create a disincentive to clear through a European CCP and may also raise issues around 'equivalency' testing for third-country CCPs," it added.
The association therefore urged ESMA to consider mandating a minimum confidence interval of 99% for cleared products in line with CPSS-IOSCO principles.
The IMA acknowledged that such a move should not prevent CCPs from being able to increase the confidence level where appropriate - for less liquid contracts, for example.
Still in the UK, the BT Pension Scheme voiced similar concerns and said it was unconvinced that the 99.5% level would automatically result in improved safety.
It also called on ESMA to restrict CCPs from the rehypothecation of non-cash collateral posted with them.
"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," it said.
"We are concerned that rehypothecation could increase systemic risk."
The Dutch Pension Federation echoed those concerns and 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.
Finally, the European Banking Authority (EBA) called on ESMA to take into account other pieces of legislation in Europe that might have an impact on the collaterals posted by pension funds.
"There appears no requirement to ensure that sufficient collateral is available at the market level," it said.
"This seems especially relevant, given that the CCPs will most likely require large amounts of high-quality collateral, which cannot be reused for other purposes."
Additionally, this issue could be "exacerbated" by the fact other pieces of regulation - most notably liquidity reporting for banks and the Solvency II regulation - also appear to increase the demand for high-quality assets, according to the banking authority.
"We suggest that ESMA considers in the cost/benefit analysis also the impact on the availability of eligible collateral required under this technical standard," it said.