EU reforms on OTC derivatives could drain schemes’ resources

While supporting the European Commission objective to introduce mandatory central clearing of OTC derivatives, the trade body warned such measures could dramatically increase the cost involved in transactions pensions schemes undertake to mitigate risk, such as interest rate and inflation swaps.

The European Commission launched a consultation on derivatives regulation in June, on the back of a G20 agreement – reached in October 2009 – to coordinate policy actions aimed at making those markets safer.

According to this agreement, G20 countries should enact legislation forcing “eligible” derivative contracts to be cleared in central counterparty (CCP) clearing houses.

Robert Gardner (pictured), co-chief executive at Redington, said these measures would imply additional administrative costs to schemes and a drag on investment performance due to the collateral that needs to be posted with the CCP.

He said: “When pension funds carry out these transactions through CCP clearing houses, they have to post cash as collateral. Therefore, they need to ensure in their portfolio they are always running a large proportion of cash available to be posted as collateral.

“This can have a major impact on their strategic asset allocation.”

In its response to the EU consultation, the NAPF said pension schemes could end up having “10% or more of their assets tied up in margin, representing a significant drag on investment performance”.  

It said: “This would reduce the affordability of pensions, already under strain from increasing longevity and introduction of legislation and regulation over the years that has turned what were originally intended as discretionary benefits into hard obligations.”

The Investment Management Association also raised concerns, calling for margin and collateral arrangements established within the CCPs to be correctly calibrated. Otherwise the cost of clearing could be borne disproportionately by individual savers through their pensions, the trade body claimed.

The EC proposed to exempt non-financial counterparties for positions not exceeding a certain threshold. And the NAPF said it was “essential” for pension schemes to be regarded as such.

In addition, Jeroen Wilbrink, structured solutions specialist at F&C Investments, said pension funds could be faced with much higher administrative costs each time they adjust their positions.

While this could be less of a problem for larger schemes, smaller ones would face increasing difficulties in hedging risks.