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A second consultation on the proposals, drawn up by a joint working group of the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (IOSCO), covering over-the-counter derivatives that are not centrally cleared closed earlier this month.
In response to the proposals, Insurance Europe says there is no economic need for insurers undertaking asset-liability management (ALM) via derivatives to post initial margin.
Insurers almost exclusively buy derivatives as hedges to improve their ALM, for example to improve interest rate cashflow matching, the trade body argues. Therefore, whenever the derivative is ‘in the money’ for the other counterparty it means the insurance portfolio has equal surplus value. This means the insurer should always be able to cover the variation margin calls from this surplus.
“So, as long this net value can be pledged to cover the risk for the counterparty, there should be no economic need for initial margin”, says Cristina Mihai, investments policy adviser at Insurance Europe, based in Brussels. “Initial margin requirements create unnecessary additional overheads that will affect the insurance business model, and moreover, have not been considered necessary by OTC counterparties dealing with insurance companies”, she adds.
Insurance Europe also fears insurers may face restrictions on the collateral they can post, despite the broad range of eligible collateral defined in the proposals. This could force them to increase their cash holdings to an uneconomic level and limit their ability to invest in long-term assets, it warns.
In the case of centrally cleared derivatives, central counterparty clearing houses (CCPs) have indicated that they will only accept cash variation margin. “There has been no indication that CCPs will expand the acceptable collateral in line with Emir [European Market Infrastructure Regulation]”, says Mihai. “The consequence of EMIR is that the insurance industry risks having to hold sub-optimal amounts of cash on its balance sheet to cover potential margin calls during normal and extreme market situations”, she adds.
The proposals on non-centrally cleared derivatives must also be flexible to integrate with other regulatory initiatives such as Solvency II, says Insurance Europe. The collateral and haircut proposals disregard Solvency II's approach for dealing with market risk in collateral and would lead to double-counting of the future collateral value risk.
The need for improving transparency, reporting and collateral coverage of derivatives is understood by the insurance industry, says Mihai. But, as is the case with other regulations, it is important to avoid unintended consequences, she argues.
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