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EU urged to help pension funds on margin calls stress

European pension funds should have access to a central bank-backed facility as a last resort to help them avoid the fire-sale of assets forced on UK pension managers, the derivatives industry’s main trade body has said.

The International Swaps and Derivatives Association (Isda) on Wednesday called for a system that would allow pension funds to more easily convert their excess collateral into cash in order to meet margin calls from clearing houses.

It comes as officials in Europe assess the implications of the UK’s pensions and bond market chaos last month, when Westminster’s “mini” budget prompted a financial crisis. The sharp and unexpected surge in gilt yields following the announcement of unfunded tax cuts triggered margin calls on derivatives for pension funds, which they met by selling assets into a falling market.

The sudden plunge in gilt prices and rapid sales threatened to spiral out of control, forcing the Bank of England to step in with a £65bn bond-buying programme in order to stabilise markets.

The paper outlined a series of recommendations to make clearing of derivatives in Europe more attractive. The vast majority of the world’s interest rate swaps are managed in London, at LCH.

Pension funds have shied away from clearing because they worried that they would not have a ready supply of money or other highly liquid assets necessary to meet margin calls.

A report from the European Commission estimated European insurance companies and pension funds had to pay an extra €50bn in margin over a 12 day period in March 2020 when markets were panicked by the impact of coronavirus.

Isda urged policymakers to “conduct an in-depth analysis of how central bank access could be intermediated to allow [pension funds] to convert high-quality liquid assets into cash, potentially limiting this to a last-resort tool that is only used in stressed market conditions,” it said.

Other Isda recommendations included promoting voluntary clearing by public companies, expanding settlement hours for euro transactions beyond 6pm, and give European clearing houses better access to central bank money. Isda said its paper had been written before the “mini” Budget.

Isda’ call was echoed on Tuesday by Dutch pension fund APG, which has around €558bn assets under management.

Pension funds “remain dependent on the willingness of banks to accept bonds as collateral,” Jan Mark van Mill, head of treasury and trading at APG, wrote on a corporate blog. “We would therefore like to see the ECB guarantee the reliability of repo markets, just like the US Fed[eral Reserve] and the Bank of Canada do.”

Banks and investors use repo markets to temporarily exchange illiquid assets for highly-liquid collateral like cash. Those assets are deposited in clearing houses.

The call comes as the Dutch central bank asked local retirement funds to check for signs of stress, recommending that they review liquidity rules and report on any need for fire sales of assets, in the wake of the problems in the UK market.

The Netherlands, the EU’s largest pensions market, has some similarities with the UK. Many Dutch pensions also use derivatives contracts open for many years to help them match their assets with their liabilities and protect against changes in interest rates.

Both European and British pension funds are currently exempt from clearing their trades through a clearing house but that exemption expires in June next year.

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