PSAs (Pension Scheme Arrangements), however, have been exempt from this obligation — an exemption that ended on 18 June 2023 for the funds active within the EU. Pension funds affected are those with a derivative position over a defined threshold — in the case of interest rate swaps, this threshold is set at €3 billion of notional.
Although European pension funds have been expecting the clearing obligation to come into force for some time – and in theory, no fund should be caught off-guard – in practice, some smaller funds still have no clearing agreements and lack the tools to manage the risks associated with their new obligations.
Non-compliance with the regulation will likely result in significant fines or penalties and potentially equally disruptive, reduced access to crucial hedging instruments in their core markets. This regime change for the sector highlights the need for pension funds to understand their margin, collateral, and overall liquidity requirements and means these firms must be prepared to make some internal changes to be compliant.
One of the critical impacts of the change in requirements is an increase in margin posting by these firms on their newly cleared trading portfolios.
Depending on the portfolio structure, fund size, and investment mandate, the impact will vary, but in many cases, the new margin requirements will significantly drag on portfolio performance as assets that were previously able to be invested are now required to be used to meet margin calls.
The CCP’s Initial Margin calculation methodologies based on VaR-style risk measures have further exaggerated these increased margin requirements for the pension funds. Given the recent volatility periods in the rates markets, the models now indicate that significant amounts of Initial Margin (IM) must be posted on relatively vanilla hedging positions.
Similarly, on a daily and potentially intraday basis, funds will now be required to post Variation Margin (VM) on their positions. This may result in volatile intraday cash margin calls in stressed markets that have, to date, not been experienced.
The focus on these funding needs has highlighted the need for many of these funds to understand their new margin, collateral, and liquidity requirements in more detail, helping them maintain resilience to the new regulation and future market moves.
By analyzing margin drivers between cleared and uncleared trading agreements, performing what-if analysis on proposed new trades before execution, and optimizing their positions across different FCMs, CCPs, or bilateral counterparties, funds can mitigate the liquidity risk to their portfolios.
Furthermore, by automating collateral and margin processes, they can manage the operational burden of an increased frequency and size of margin calls and the settlement challenges associated with intraday cash posting.
The end of the regulatory exemption brings PSAs back in line with the rest of the market regarding their clearing obligations, reducing counterparty risk within the broader market.
The firms impacted can take advantage of the liquidity risk management strategies practiced by banks, asset managers, and some hedge funds to understand the best practices for margin and collateral processes and analytics.