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Certain elements of the CRDIV bank capital rules have strong opposing incentives for banks to only receive variation margin in cash to support non-cleared OTC derivatives positions. More precisely, the leverage ratio and net stable funding ratio (NSFR) rules could force pension funds to post Variation Margin in cash only, and not permit other assets for collateralizing non-cleared derivative trades. This directly contradicts the EMIR policymakers’ objective and would force pension schemes to have to post variation margin in cash for non-cleared trades as well. It would introduce disproportionate cost and risk to EU pensioners.
In addition the leverage ratio and NSFR rules only allow cash Variation Margin to offset any positive mark-to-market exposures borne by a bank on OTC derivatives positions. Non-cash VM, even high quality government bonds, are not permitted to offset the mark-to-market exposures. As a result, many banks are now restricting OTC derivatives trades to those that are collateralised with cash VM only, where previously banks would also accept high quality government bonds as VM.
The Capital requirements for banks, imposed by Basel III and CRDIV rules, have had also a negative impact on market liquidity, especially in the repo market. In fact, CRDIV and CRR restrict the liquidity on the repo market.
We suggest policymakers to consider allowing high-quality government bonds with appropriate haircuts to offset the mark-to-market exposures of OTC derivatives in leverage ratio and NSFR calculations and to exempt pension funds from posting collateral in non-cleared transactions until non-cash solutions for posting collateral are developed.