EMIR exemption for pension funds: only half the story

​Basel III/CRDIV requirements effectively prevent banks from accepting non-cash collateral. As a result pension funds, which need derivatives to hedge interest rate risks are now confronted with increasing demand for cash.

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Pension funds have been granted a temporary exemption on the mandatory central clearing for derivatives. This exemption is only meaningful when there is a realistic alternative. We notice that the alternative, the market for non-cleared OTC derivatives, is changing rapidly and becomes similar to the cleared market. The impact on pension funds is equally disproportional compared to the negative impact calculated if mandatory clearing for pension funds is implemented. A permanent exemption to the obligation is therefore not an optimal solution.

The reason for this is simple: the exemption only addresses one aspect of the issue. Foregoing the requirement of mandatory clearing for pension funds does nothing to address the issues that arise on the side of banking rules that impact the ability of pension funds to enter into derivative transactions. The banking rules are in fact pushing banks to accept only cash as collateral, not only for cleared trades but also for non-cleared transactions.

Exacerbating the problem is the fact that liquidity in the repo markets is decreasing. The importance of a well-functioning repo market will increase significantly due to amongst others, the increased demand for cash collateral. However, as a result of bank capital rules the willingness of banks to act as liquidity providers to the repo market is diminishing rapidly. A sub-optimal or non-functioning repo market poses a threat to financial stability and further increases the need for the ability to post non-cash collateral.

If a solution is not found, pension funds will be obliged to maintain ever larger liquidity buffers eating away at pension fund returns. Liquidity buffers form a drag on performance as the expected returns on cash are much lower than for example expected returns on equities and real estate but also government bonds. It has been calculated (and confirmed by the European Commission) that the liquidity buffers pension funds would be required to hold, are of such magnitude that they would lower expected returns by 0,50% point.

Therefore a solution is required to counter the negative consequences of EMIR and the new banking capital rules. We have shared our views on this issue on multiple occasions and most recently by responding to two consultations (Basel III (Revisions to the Basel III leverage ratio framework) and the European Committee (Further consideration with regard to the implementation of the NFSR)). We urge to investigate the possibility to treat HQLA-collateral (High Quality Liquid Assets) in a similar way as cash-collateral. In our opinion this would take away many issues for end-users and makes the entire financial system more resilient towards liquidity crises.

In addition attention should be paid to the rapidly decreasing liquidity in the repo markets. The combination of both an increasing cash demand and a decreasing liquidity in the repo market can pose a serious threat to the stability of the financial system especially in situations of stress.

Click here and here to consult PGGM responses to Basel and EU Commission consultations

Anja Kleefsman

Senior Investment Manager

Head of Treasury & Client Portfolio Management

Expert policy advisor Public Affairs

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