In a July response to a consultation on draft regulatory standards for uncleared trades under the European Market Infrastructure Regulation (Emir), Insurance Europe highlighted concerns about the speed with which new rules will be introduced and worries about the eligibility criteria for collateral. 

 

“Every effort should be made to ensure that costs associated with non-centrally cleared derivatives do not become prohibitively high and eventually harm policyholders,” stated the association. 

“Our concern goes far beyond the IT and operational costs to firms,” says Cristina Mihai, policy adviser, investments, at Insurance Europe, based in Brussels. “Post-EMIR, insurers will have to hold cash for covering daily variation margins, and that could have an impact on asset holdings. Insurers typically have limited holdings of cash, especially life insurers. The pressure to hold cash could be the highest cost for the insurance company. What the impact of that will be, we will only see over time.” 

 

EMIR will require all derivatives trades either to clear centrally or to meet the criteria being set down for uncleared transactions. For both types of trade, insurers will face more stringent requirements to post initial and variation margin. 

 

The European supervisory authorities (the European Securities and Markets Authority, the European Banking Authority and European Insurance and Occupational Pensions Authority) are expected to submit draft technical standards to the European Commission towards the end of the year after which finalised rules will be submitted to the European Parliament and Council early in 2015, leaving only months from the regime becoming official to the rules taking effect. 

 

“You can say that insurers have had time to prepare and they were aware of the potential rules, but that isn’t true. There are a number of provisions that must be reflected in each and every bilateral contract, so firms will have to renegotiate contracts on a bilateral basis,” says Mihai. 

Insurers will have to renegotiate the terms of many existing derivatives contracts to accommodate new credit criteria and concentration limits that apply to the assets they post as collateral. Firms will also face an operational challenge to prepare to carry out daily collateral exchanges and manage the composition of collateral pools as required under the new rules. 

 

“If sovereign bonds go up and you discover that the weighting in the collateral portfolio is higher than allowed, you need to rebalance the portfolio. Most likely insurers will rebalance with what they already have, but even so, insurers will need to redefine a huge number of procedures. It is not something that can be done in just a few months,” says Mihai.

 

These concentration limits aim to protect against a counterparty being unable to sell collateral quickly when needed. But Insurance Europe points out that the requirements on sovereign debt contradict the position in Solvency II where government bonds are treated as highly liquid and thus exempted from capital charges for concentration risk. “In the euro area, it is hard to imagine how the dissolution of a collateral portfolio could cause a liquidity problem,” says Mihai.  

 

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