The European Commission has set up an industry working group with pension funds, banks, clearing houses and central securities depositories (CSDs) to find a solution for pension funds providing variation margin for their centrally cleared derivatives.
Pension funds currently face mounting complications with providing cash collateral as variation margin for their cleared derivatives, and up until this point, no solution has been found for them.
Pension funds have been exempt from the clearing obligation as a result, and the European Securities and Markets Authority (ESMA) has proposed to extend this exemption to June 2021. This is due to the characteristics of some pension funds’ derivatives portfolios, which are typically long-dated and unidirectional, meaning they do not typically hold cash to post as variation margin to clearing houses.
However, regulators are concerned that by frequently extending the exemption, it will not solve the variation margin problem for pension funds as liquidity has increasingly shifted to the cleared market, due to heightened capital and collateral costs in for bilateral OTC derivatives.
With no solution currently insight, the European Commission has set up a dedicated stakeholder group bringing together key industry participants to work on a solution.
“The European Commission has set up a dedicated stakeholder group which brings together pension funds, CCPs, banks, CSDs, EU policymakers and central banks in order to work on a robust solution to the cash VM issue that can be relied upon in stressed market conditions,” ESMA stated in a recent consultation. “This may imply the assurance of a liquidity provider to transform high-quality government bonds into cash at a cost.”
Some banks and clearing houses have pushed for collateral transformation services as a potential solution for pension funds. Yet according to ESMA’s report, banks have been reluctant to extend collateral transformation services to variation margin flows due to concerns of the impact it would have on their balance sheet.
ESMA is currently asking for industry feedback as to how it can progress on solutions for the pension fund community, and what it should recommend to the European Commission.