04 May 2011

GFS: Unlevel playing field concerns on pension clearing requirements

The European insurance industry has warned against allowing OTC derivatives proposals to exempt pension funds from clearing requirements, arguing it would put its members on an unlevel playing field.

Recognising that there is "some debate" as to whether pension funds should be exempted from the requirements, the CEA argues that instead of granting exemptions for any long term investors, proposals should recognise different risk profiles held by market participants. "Exemptions run the risk of creating an unlevel playing field between sectors, and offer more opportunities for inappropriate actors to attempt to bypass the regulation," letters sent to the European Parliament and European Council yesterday state.

"Insurers would prefer to see the universal application of the clearing obligation to financial counterparties, but with greater options on the type of assets that can be used as collateral for margin." The debate stems around the issue of central counterparties, designed to absorb the risks facing individual firms should one party in a derivatives trade default - however, this will come at a greater cost to firms making the trades.

The CEA also admits it is "very concerned" that recent changes to the text have removed the provision to accept both cash and highly liquid financial instruments to meet margin requirements. It argues that insurers do not have large cash holdings because they hold long-term obligations - meaning that if they were forced to post only cash collateral, they would have to liquidate long-term positions and assets to fulfil margin requirements.

They argue this would ultimately come at a cost to their underlying clients who would lose out on investment performance. "We suggest that it would be feasible for long-term assets to be used instead of cash - but with an appropriate reduction (haircut) to account for the possible decline in value that many occur before they can be liquidated in the unlikely event of a default.

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