Roundtable: Pension schemes have been granted a transitional exemption from having to centrally clear derivatives – a rule contained in the European Market Infrastructure Regulation – but the exemption will end in August 2017. How will schemes be affected and how are they preparing? In the third part of this roundtable series, Bestrustees’ Huw Evans, HR Trustees’ Giles Payne, Aviva Investors’ Rakesh Girdharlal, KPMG’s Simeon Willis, Cambridge Associates’ Benoît Jacquemont and P-Solve Asset Solutions’ Barbara Saunders discuss what the new requirement will mean for schemes.
Giles Payne: The extension of the exemption for pension schemes [from centrally clearing over-the-counter derivatives until August 2017] is very welcome. The European Market Infrastructure Regulation will continue to affect pension schemes and their ability to leverage their interest and inflation risks. It means trustees will not be able to just set their hedges and forget them.
Barbara Saunders: Pension schemes are delegating preparation for Emir to their investment managers mostly. And I think most investment managers are being very proactive in ensuring compliance.
It does create challenges for the overall investment strategy, because you need more collateral and potentially you have lower leverage levels, but I think it is manageable.
Even with the changes, when they do come in, it will still be a very useful tool for pension schemes to use.
Benoît Jacquemont: It created an immediate need, from an LDI portfolio management point of view, of creating an efficient management of collateral processes, a waterfall process, because you will have to supply cash.
Most of the pension funds have gilt as collateral; so what you see in the portfolio management industry is that they have been much more efficient in terms of categorising the type of collateral they have, from very illiquid towards very liquid, so that they know, each time there is a requirement of collateral margin, which pool of collateral they can tap into.
The main impact of Emir is an increase in cost for the ongoing management of these LDI strategies, and it comes from two angles. One is because you have to post cash and clearly you would have probably preferred having some gilts as collateral, which is yielding you higher interest rates, so there is a cost of opportunity in having to post and maintain a cash buffer in your investment portfolio.
And the other is that you are going to hold these swaps for a very long period and therefore the maintenance of your ongoing position at the clearing house is going to cost you a lot of money as well.
Huw Evans: So I am hearing not particularly good news for LDI. On the other hand, it is worth keeping an eye on the IORP directive as that progresses through the European Parliament, because the piece it has around governance and risk may change the appetite for LDI in this country.
Rakesh Girdharlal: On clearing, we have seen a lot of clients at least become clearing-ready, so have the necessary documentation in place to be able to trade cleared swaps.
And most pension clients have preferred bilateral swaps, swaps with a counterparty, which are collateralised primarily with gilts, because pension schemes do hold a significant proportion of their assets in gilts.
What they will find is that, trading bilaterally with the gilt CSA or with gilt posted as collateral, it will become more expensive over time to put on new positions with the counterparty.
So they will be moving towards what would be the most liquid and cheapest form to transact these swaps, which will become a cleared market or a market where, ultimately, you will be collateralising all your swaps purely with cash.
Saunders: A big part of Emir is also all the data reporting that has had to be done. Now every trade must be registered with the trade repository; they have to have thousands of lines of data for each individual swap.
So all the managers and all the LDI providers out there are diligently providing all this information, but I am not sure either the trade repositories or the regulators know what to do with it.
Simeon Willis:
In terms of the overall impact of Emir, I think it depends heavily on whether you are in a pooled solution or a segregated one. If you are in a pooled solution, then the fund manager is going to take care of it and from what I have heard from managers we have spoken to so far, they do not have an expectation that it is going to change the level of leverage they can employ, but we may see that change as things emerge.
Where it is going to be of more significance and more effort from trustees is for segregated arrangements.
And we are likely to go through a similar process as we did around three or four years ago, when there was a change in the valuation basis of Libor to Sonia for swaps, involving a change in the CSAs that sit behind those swaps.
We are encouraging clients to think opportunistically, to not leave it until the last minute but start considering this now, because if you do leave it until close to the [end of the] exemption, then there will be a lot of effort and a lot of rush and it may not result in as good an outcome as could be achieved with a bit more planning.
Typically, segregated arrangements are in relation to larger schemes, but there are a number of smaller schemes that have segregated arrangements as well, and they would be well advised to consider it.
Because we saw in February 2014 – when an Emir regulation came in that required schemes to report the trades they were entering into – that for a number of schemes it involved a lot of last-minute running around because they had not planned, and they perhaps had to appoint a custodian to do this reporting on their behalf.
And it was a trustee responsibility, not a fund manager responsibility.
Saunders: It depends on the manager, because in some cases the managers were quite proactive in helping their clients comply. It is a trustee responsibility, but I think the investment managers are helping trustees along with that, from what we have seen.
