23 May 2011

FN: EU compromise fails to remove pensions threat

Guy Verhofstadt writes that the debate over new over-the-counter derivatives rules comes to a head with a crucial vote in the European Parliament. He says that MEPs should bear in mind that the current proposals will still lead to higher costs and lower payouts for pension funds in the years ahead.

All OTC derivatives will have to be cleared through a central counterparty, and assets will have to be posted as collateral (in the form of upfront and daily variation margin). Derivatives that are not cleared via a CCP will be subject to added capital requirements, although the details of this are not yet known.

One topic is whether pension funds should be excluded. It seems that policymakers in Brussels, in the Council and in the European Parliament recognise that pension funds have a justified case. A three-year exclusion is being discussed but this is not good enough. The temporary exemption from the clearing requirement would only postpone the discussion to a later stage.

Why would it be logical to exclude pension funds now and put them under the derivatives regulation after three years? European pension funds are conservative long-term investors, using liability-driven strategies. They are heavily regulated. Therefore, they hedge their exposure to changes in interest rates, currency rates and inflation by using OTC derivatives. Their use of OTC derivatives is only possible insofar as it contributes to the reduction of investment risks, as already stipulated by the European IORP directive.

Pension funds are not allowed to speculate with OTC derivatives. Forcing pension funds into central clearing implies higher risks and costs, and few advantages. If pension funds are forced to clear through a CCP, they will be required to post collateral to a CCP. At present, it is only the less creditworthy market participants that have to post upfront margin.

Pension funds do not want to be obliged to bear the risks of such parties, or even subsidise their activities. As hedging end-users, pension funds did not cause the financial crises. From a pension fund’s risk perspective, mandatory participation in a central clearing system does not add value above the currently functioning bilateral derivatives arrangements, which are properly netted and collateralised and accompanied by optimal risk management tools.

Pension funds believe transparency and risk management are elements to reduce systemic risk in the OTC derivatives markets. As long as they do not have to disclose their OTC position instantly and in a detailed way, they are prepared for transparency requirements and strict risk management requirements for their bilateral OTC trades.

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