Margin requirements for non-centrally cleared derivatives: a response by NAPF
A series of international initiatives is looking to inject extra regulation and transparency requirements into the trade in over-the-counter (OTC) derivatives, including mandatory central clearing. This work dates back to a declaration at the Pittsburgh G20 meeting in 2009, which demanded new safeguards to help prevent a repeat of the financial crisis.
Pension schemes make extensive use of derivatives to manage and reduce their risks – particularly their exposures to future movements in inflation and interest rates. So new regulatory requirements in this area have an impact on NAPF members.
A key element in the reforms is a concerted effort to ensure that more derivatives trades are conducted via exchanges, rather than direct between two parties. Transactions that are conducted away from exchanges are known as ‘over the counter’ or ‘OTC’ trades.
The legislation that will implement the new approach in the EU provides a 3-year exemption from central clearing for pension schemes until 2015, extendable to 2018. In the meantime, OTC derivatives trades will be made subject to new requirements that will require the transacting parties to post margin as part of the transaction. This provides protection in case of default by one of the parties to the transaction.
Two international bodies – the Bank of International Settlements (BIS) and the International Organisation of Securities Commissions (IOSCO) are drawing up standards for calculating the amounts of margin to be posted as part of OTC derivatives trades, and these will eventually be adopted in the EU.
The NAPF’s response to the BIS / IOSCO consultation on margin requirements is here. It says:
- Pension schemes use derivatives largely to hedge liabilities and, thereby, reduce risk. Extra costs or processes that provide a disincentive for pension schemes to use derivatives could in fact increase the degree of risk in the markets.
- The new margin requirements would significantly increase the cost of hedging to pension schemes. This would have an impact on individual pension scheme members through lower pensions, increased contributions, increased risks, higher pension ages or scheme closures.
- Pension schemes exhibit low systemic risk. Indeed, they are obliged by the EU Directive on Institutions for Occupational Retirement Provision (‘IORP Directive’) and by UK trust law to use derivatives in a carefully risk-controlled manner. Ideally, this should be recognised by exempting pension schemes from the new initial margining requirements. If this is not possible, then an alternative approach would be to reflect pension schemes’ creditworthiness and the long-term one-direction nature of their derivatives positions by reducing the amounts of collateral that they are required to post.