EMIR and collateral costs for pension funds: new framework

There’s good news and more clarity for pension funds reviewing their derivatives investment strategy in the light of the European Market Infrastructure Regulation (EMIR). The final framework for margin requirements for non-centrally cleared derivatives confirms thresholds and relaxations, which, if adopted by the joint European supervisory authorities for EMIR, should go some way to reduce the potential increase in the cost of transacting in non-centrally cleared derivatives.

EMIR imposes clearing requirements in relation to over-the-counter derivative contracts and reporting requirements in relation to derivative contracts and sets requirements for non-centrally cleared contracts, including in relation to collateral. Most pension funds have a three-year partial exemption from the central clearing requirement (which may be extended for a further two years after review) but are subject to collateral requirements for non-centrally cleared derivative contracts. These collateral requirements have been a cause of concern for pension funds.

Initial margin requirements could increase costs: pension funds are not normally required to post initial margin (which protects transacting parties from the risk of counterparty default) by virtue of their low counterparty risk status. High levels of mandatory initial margin would require funds to set aside large reserves, potentially reducing returns and restricting the effectiveness of hedging. Restrictions on the types of asset required to be posted as either initial or variation margin could have an impact on funds’ investment strategies…

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