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Impact Investing

IPE special report May 2018

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Pension funds await decision on derivative-trade exemption ruling

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  • The European Commission

Results of debates on how much extra time pension funds will be granted for their present exemption from having to process derivative trades via central counterparty clearing houses (CCPs) will emerge, probably on 14 August, when the European Commission presents a report on the matter.

Indications from different sources, which prefer not to be named, are that solid efforts are currently in hand to accommodate pension fund interests, which object to the extra cost they could face.

One item on the table is the category of collateral that clearing houses may be willing to take.

An item is whether a pension fund might be able to offer non-cash collateral.

Also in discussion is how to deal with the shortage of offsetting trades for swaps.

Unless decided otherwise, rules under the European Market Infrastructure Regulation (EMIR) mean the pension exemption will run out in August 2015. 

The legislation, intended to mitigate risk of catastrophic financial meltdown, has been stepping up its rules on trading in derivates since September 2013.

The Commission’s forthcoming report is likely to be based on a study from London consultancy firm, Europe Economics – ‘Possible technical solutions for the transfer of non-cash collateral as variation margins by pension scheme arrangements (PSAs) in respect of centrally cleared over-the-counter (OTC) derivative transactions’.

It was further instructed to assess “the costs and risks of the various solutions and their impact on the retirement income of future pensioners”.

PensionsEurope, representing Europe’s occupational pension schemes, is concerned that clearing would increase pension fund costs, thereby leading to lower payouts to pension beneficiaries.

Its basic viewpoint includes that derivates are used for hedging, and never for speculation, which would be banned under IORP rules.

The current position of the Commission is that it is in the process of deciding whether to extend or not the temporary exception of IORPs from clearing.

Yet Nicolas Gauthier, a European Commission official, noted at a recent Brussels conference that some pension funds “were already clearing”.  

Gauthier also mentioned “future meaningful international convergence”.

He raised the subject of “risk of arbitrage and risk to security” and referred to the need for “cooperation between [international] regulators in order to achieve reform”.

The conference, on reform of OTC derivative markets, was organised by the Brussels think-tank the Centre for European Policy Studies (CEPS).

Addressing IPE at the conference, the secretary general of the Brussels-based European Association of CCP Clearing Houses, which opened its doors earlier this year, said: “We understand the pension sector’s problem, and we are committed to finding a solution.”

Rafael Plata indicated that one relevant issue involved the type of collateral a clearing house was willing to accept.

Normally, a CCP would insist on high-grade collateral to avoid being put at risk, he said.

The clearing organisation would have the last say.

Philip Whitehurst of LCH.Clearnet, a CCP, told IPE that pension funds had in recent years developed and implemented liability-driven investment (LDI) strategies to free up cash to use for high-yielding investments.

The challenge now, said Whitehurst, is to ensure pension schemes are using swaps with adequate collateralisation, whilst retaining scope to seek additional alpha.

The product manager at LCH.Clearnet, which is majority owned by London Stock Exchange Group, added that recent figures from the International Swaps & Derivatives Association (ISDA) showed that the global notional outstanding OTC value had now grown to $710trn (€521.5trn).

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