EUROPE - EU proposals that over-the-counter derivatives go through a central clearing counterparty could significantly increase costs for schemes.
Draft proposals on OTC derivatives, central counterparties and trade repositories – published by the European Commission this month – indicate pension funds and other institutional investors would have to post cash, rather than gilts, as collateral and have it held by a central clearer.
Such a move would both increase the cost of derivatives and of derivative-based investment strategies, such as liability-driven investment.
P-Solve deputy chief investment officer Ben Clissold said: “EU proposals for derivative clearing will add greater cost to pension schemes. Pension schemes don’t have a lot of cash, they have a lot of gilts. These can be turned into cash on exchange, although this will be an additional expense.”
M&G director of fixed income John Atkin said the effective rates of returns on this cash collateral could be as little as Libor less 37.5 basis points, once all extraneous costs are taken into account.
He added: “This is an unintended consequence and pension funds should engage with their advisers now – while still in the initial consultation phase, before it becomes legislation.”
F&C structured solutions product specialist Jeroen Wilbrink said: “[OTC regulation] will have an impact on the LDI market. We’ll have to be clever about how we apply LDI. We’ll have to incorporate cash components in the structure. We’ve developed an LDI product that doesn’t use OTC derivatives but uses listed derivatives and bonds. So there will be a lot of things changing in the next couple of years.
“We’ll all have to adapt to the world of central clearing. I think it’s pretty much certain this will be adopted. We have to be prepared.”
Wilbrink added: “The total requirement on the pension scheme balance sheets will be enormous compared to what banks have to post…all in all, it can be a strain on pension schemes going forward.”
The current phase of the consultation period is due to end 15 November.
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