Pension funds across Europe are yet again facing an obligation to clear derivatives themselves because of the upcoming revision to the European Markets Infrastructure Regulation.
Under rules of the original EMIR, all counterparties trading in the European Union are required to post cash, rather than bonds, as the collateral to clear derivatives' exposures. This means institutional investors will have to liquidate otherwise long-term fixed-income investments if they are to be used as collateral.
An exemption to the clearing rules — the second granted since 2016 in an effort to find a different method for pension funds before EMIR Refit, as it is known, goes into effect in March — expired in August. A source close to European decision-makers said a permanent exemption is not in the cards.
Sacrificing return for short-term liquidity through larger allocations to cash does not sit well with pension funds that have large liabilities, sources said. Instead, pension fund executives wanted to see a market fix that would either help them efficiently transform bonds into cash at favorable rates or simply post bonds as collateral for the variation margin, as they already can do with the initial margin requirement.
Some pension funds, trying to mitigate the impact of the directive's requirements, already have lined their portfolios with higher cash allocations; others are outsourcing collateral-posting to money managers. Either way, asset owners have to hurry.
"We are expecting to get amendment to EMIR (known as EMIR Refit) over the line in the next month or so, but certainly before the end of the year," said Kay Swinburne, member of the European Parliament and vice chairwoman of its economic and monetary affairs committee in Brussels.
"(The market) hasn't found the solution for (pension funds) yet ... but the solution has to be found and acted upon in a very short period of time," she said.
"We envisage (the market) is still looking for a technical solution that will allow pension funds not to have to post cash as variation margin ... they are looking at what that might mean for a central counterparty or central bank involvement to provide liquidity to allow a specialist repo platform. We are negotiating on the basis that there will be a solution — and are now debating how long that solution will take to conclude and then be implemented between three and five years."