EUROPE - The European Parliament has adopted a 'soft' approach to pension funds on the new European Market Infrastructure Regulation (EMIR) directive on over-the-counter (OTC) derivatives, confirming that they will be exempted from the legislation temporarily.

After protracted negotiations, a compromise agreement to regulate trade in OTC derivatives has finally been agreed by both the Parliament and European Council representatives.

Under the agreement, European pension funds will be exempted from the EMIR directive for three years, although it is still unclear whether the reprieve will be extended.

After three years, the European Commission will revise the regulation to ensure the effectiveness of the supervisory framework for central counterparties (CCPs). 

Parliament said the exemption aimed to prevent pension funds from incurring disproportionate costs that could ultimately impact European pensioners.

Conrad Holmboe, associate with the investment consultancy Redington, told IPE:  "I think the European Parliament is slowly realising that some of the legislation might have unforeseen implications for pension funds, which may not necessarily be in their best interest."
"Most pension funds who use swaps have CSAs in place with bilateral, daily collateralisation and will post either cash or gilts.
"If pension funds choose to centrally clear their OTC derivatives they will have to post both initial and variation margin, the latter in the form of cash only."

According to Holmboe, when it comes to initial margin, the new regulation does not differentiate between those that use OTC derivatives to hedge, such as pension funds, and those that use them to speculate, such as hedge funds.

"It can easily be argued that one represents a much greater risk to the system than the other", he said.

He also said pension funds might have to change their levels of cash.

"Historically pension funds have held low levels of cash, which they primarily use to pay member benefits", Holmboe added. "But pension funds that use central clearing will now need to hold extra cash to meet daily variation margin, which could be a drag on the long term performance of the fund."
"One of the options the European Commission should consider is allowing pension funds to post gilts as variation margin and to exempt them from posting initial margin if they centrally clear their OTC derivatives."

However, the Parliament insisted that, once the industry developed the appropriate technical solutions for the provision of non-cash collateral, pension funds would be subject to central clearing.