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​PensionsEurope warns of ‘significant burden’ of collateral regulation

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Introducing concentration limits on the types of assets counterparties may accept as collateral during derivatives trades could result in significant burdens to pension funds and increase trading costs, PensionsEurope has said.

The umbrella group for Europe’s pension associations also warned there would be disproportionate costs if the sector was forced to post initial margin, pointing to individual funds’ inability to access low-cost liquidity, compared with the banking sector’s access to central bank credit lines.

The association was responding to a consultation by the European supervisory authorities – comprising the European Insurance and Occupational Pensions Authority, the securities and markets authority ESMA and the banking supervisor EBA – on draft regulatory technical standards (RTS) for over the counter derivatives not cleared by a central counterparty, an area addressed in the European Market Infrastructure Regulation (EMIR). IORPs enjoy a temporary exemption from EMIR.

”Requiring IORPs and their asset managers to post initial margin, as opposed to the current practice [of no initial margin], would create significant costs for IORPS and their beneficiaries and would therefore be against the rationale of such exemption since it would render it completely otiose,” the response said.

The authorities further propose caps on the amount of collateral they can accept from any one issuer.

This could be problematic for pension funds, as they are likely to use their high-rated government bond holdings as collateral, and those portfolios tend to be concentrated in their domestic government’s bonds or in the largest, most liquid markets, such as UK Gilts, German Bunds or Dutch government bonds.

PensionsEurope insisted any concentration limits would result in pension funds needing to sell assets to post collateral for trades. 

The consultation also raised concerns counterparties would be unable to close their exposure if they were forced to liquidate “substantial amounts” of single securities in times of market uncertainty.  

“Importantly, concentration limits on government bonds will also introduce unwanted valuation issues for derivatives,” it said.

“Indeed, when high-grade government bonds are posted as collateral, the valuation of the accompanying derivatives is straightforward.

“The requirement of diversification in government bonds as collateral will lead to difficulties in valuation of derivatives and therefore disturb secondary markets.

“This is to the disadvantage of the IORPs that rely on efficient markets in derivative instruments.”

The organisation also warned that capping the government bond use for collateral could adversely impact a country’s ability to finance itself, and said it was therefore strongly in favour of dropping any cap consideration.

Instead, it suggested that as a compromise the European supervisors should consider limiting the percentage of a country’s overall issuance that can be used as collateral.

It concluded that the “very low” counterparty risk of pension funds, reliant on derivatives to decrease investment risk, needed to be addressed further by European supervisors.

It stressed that it would increase costs for pension funds and negatively affect their ability to provide retirement benefits.

“Moreover, IORPs and their dedicated asset managers would have less available resources to capitalise long-term investments in Europe,” it said.

The European supervisors have promised to finalise the RTS by the end of 2014

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