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Clearer Prospect for Pension Funds

The WSJ reported on Friday that the EC has privately indicated that it will recommend a two year extension to pension funds’ clearing exemption under EMIR. The clock on the three year exemption has been running since EMIR’s entry into force on 16 August 2012, if granted the extension will run until August 2017[1]. Pension funds are justified in pointing out that until the advent of mandatory clearing, the exemption exempts them from nothing. As a group, pension funds are particularly sensitive to the clearing mandate; unaccustomed to posting margin, their hedging needs typically call for long-dated Interest Rate and Inflation swaps which are likely to be expensive on an initial basis, while the unidirectional, high PV01 nature of their books will require holding large cash amounts to cover calls on variation margin. A July 2014 EC-commissioned study estimated the cost to pension funds’ long-term returns at 3.7%, and that a 1% rise in interest rates would trigger an £80-100bn. cash call. The rumoured, but very likely, extension will do nothing to solve the essential problem- the pension industry is necessarily cash-poor and is rightfully sceptical of the repo market’s transformational ability in the amounts needed. While CCPs point out the implications for systemic risk in their being forced to cash substitutes, it is unlikely the two sides will reach common ground anytime soon. The suggested solution, that central banks extend liquidity schemes to CCPs, guaranteeing “repo-ability” in even the stormiest weather is likely to be the compromise solution. Given that the risk-aggregating CCPs are already recognised as implicitly TBTF, this solution only represents a minor extension to taxpayers’ existing theoretical liability.


[1] Article 85(2) EMIR allows for a maximum of two extensions and up to a maximum of three years.

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