The Dutch pension fund manager PGGM has called for central bank liquidity help should the European Market Infrastructure Regulation (EMIR) not change to favour pension fund assets.
PGGM said it supported the founding principles of EMIR but the implications of posting cash as collateral with over-the-counter (OTC) derivatives were too great to allow it to continue as they are.
It said it wanted the regulations to be changed to allow for the posting of high-quality government bonds instead of cash as its first preference, suggesting it was possible under current wording.
However, in lieu of an agreement on this between the European Commission, regulators and central counterparties (CCP), it suggested assistance in developing wider, and more pension fund-friendly, repurchase agreement (repo) markets.
If this was not possible, it called for a permanent exemption for pension funds from EMIR, but stressed its preference either of the first two options.
Pension funds are currently exempt until August 2017 from using CCPs to clear OTC derivatives with regulators unable to find an answer to the collateral conundrum.
Under current rules, OTC derivatives must post cash as collateral with CCPs. However, pension funds’ asset allocations and minimal cash holdings mean the requirement adversely affects investment returns and ability to pay pensions.
It would also mean in times of market stress, where collateral postings could increase quickly and dramatically, pension funds would be forced to liquidate other assets on unfavourable terms in order to meet collateral cash calls.
PGGM said pension funds should be able to post non-cash assets without affecting the pricing or liquidity of the underlying derivative contract.
It added: “Until now, no comprehensive solutions have been identified or implemented. Pension funds cannot solve this issue by themselves: it is also the responsibility of the clearing industry and the legislators.”
However, it said if the industry could not find a solution to posting non-cash assets, stakeholders need to address liquidity and transformation risk in stressed markets when pension funds need to liquidate assets – suggesting help from central banks.
It said current repo markets were not deep enough nor suitable for pension fund usage to the level required for derivative transactions.
Such markets are also prone to liquidity risks and dry up under market stress.
“It is important to acknowledge that central banks provide the only reliable source of market liquidity in stressed market conditions,” the scheme said.
“One potential solution could be to explore the feasibility of a guaranteed repo facility that pension funds could access under extreme market conditions.”
The scheme said it recognised the principles behind EMIR and how using CCPs for OTC derivatives was essential to this.
“We can only support central clearing for pension funds if a robust solution is found,” it said.
PGGM suggested the 2017 delay – implemented in order to find a solution – has not been used effectively, with EMIR yet to be fully launched for other OTC derivative users.
“To date, the temporary pension fund exemption has not delivered what was originally intended as pension funds have been exempt from a clearing obligation that still does not exist,” it said.