Some of the proposals in the European Commission’s Public consultation on derivatives and market infrastructures will increase risk and costs of pension funds, warns the European Forum for Retirement Provision (EFRP).

In response to the EC’s consultation, the EFRP addresses key issues that may greatly impact Institutions for Occupational Retirement Provision (IORPs), and is concerned that mandatory participation in a central counterparty (CPP) will increase counterparty risk.

Therefore, the EFRP is in favour of a “carve-out” for pension funds, making clearing through a CCP optional instead of mandatory – this would not affect systemic risk as IORPs are prohibited from using derivatives for speculative purposes. Pension funds would be able to select a solution that is most favourable for their plan members in terms of counterparty risk, and therefore would qualify as a Pareto improvement.

The EFRP said clearing through a CCP would increase costs for pension funds, and so the Commission’s proposal would impose uniform margin requirements to cover losses resulting from at least 99 per cent of price movements. This, the EFRP, would be “a crude method” and disadvantageous for IORPs, as the probability of them defaulting is negligible since they solely invest paid-in contributions for the good of the plan members.

The fear the EFRP has is that clearing through a CCP would result in pension funds “cross-subsidising speculative activities of hedge funds and banks’ proprietary trading desks”.

A solution, the EFRP said, is for CCPs to be required to take into account the creditworthiness of market participants in setting margin requirements, with low risk participants having to post low levels of collateral, and be required to accept government bonds to cover initial and variation margin requirements.

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