ESMA denies pension funds extended clearing exemption

Pension funds will have to begin clearing OTC derivatives contracts on 17 August 2018, despite calls for a third extension.

Pension funds will no longer be spared from mandatory clearing of OTC derivatives from August after Europe’s regulatory watchdog refused to extend their exemption from the ruling.

A statement from the European Securities and Markets Authority (ESMA) said “there is no possibility” to extend the temporary exemption for pension funds from the clearing obligation.

Two temporary exemptions had already been applied to allow time for clearing houses to implement a technical solution for the transfer of non-cash collateral as variation margin.  

However, a solution has not yet come about, and, despite calls from both the European Parliament and the Council on the extension of the temporary exemption, ESMA deemed they are legally obliged to enforce the requirements.

“ESMA nonetheless acknowledges the difficulties that certain PSAs (pension scheme arrangements) would face to start clearing their OTC derivatives contracts on 17 August 2018,” ESMA stated.

Damning concerns have been raised by many pension funds that they could be forced out of the derivatives market if the rules regarding the posting of non-cash collateral were not changed.

In 2016, a joint letter signed by the CEOs and CIOs of Dutch pension funds PGGM, MN and APG Asset Management, and Insight Investment, warned the rules restricting the use of non-cash collateral, such as government bonds, would reduce liquidity in the OTC derivatives market and could result in them being shut out.

Furthermore, what is most alarming for Europe’s pension funds though is the leverage ratio and net stable funding ratio rules, which require pension funds to post variation margin in cash only for their non-cleared derivatives trades. The letter said banks are refusing to accept high quality government bonds because they are not permitted to offset market-to-market exposures

According to a paper from the Europe Economics and Bourse Consult in 2012, it estimated that an extra €205 billion to €420 billion of cash collateral would be needed if European pension funds were required to post cash variation margin.