Response to joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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The requirement to use repo under the first option brings increased risk, such as operational risk or roll risk, to the pension scheme in question.
The second option of posting non-government bonds (typically of lower quality and liquidity than gilts) also adds risks, such as operational risk, as the non-government bonds to be posted will normally be managed by a different investment manager to the agent arranging the posting of collateral. Such arrangements are currently typically avoided at present due to the likes of operational risk should say the investment manager try to sell a specific bond at the same time as the collateral agent tries to post the specific bond as collateral. Such collateral is also less attractive due to its lower liquidity and typically lower credit quality, leading to larger haircuts.
Due to the unattractive nature of the two options outlined above pension schemes may attempt to separate legacy and new transactions. This would require the likes of two Credit Support Annexes (CSAs) with each OTC derivatives counterparty which would:
• reduce portability in counterparty failure events and make replacement of transactions more challenging going forward
• add material management and operational complexity and risk
• make portfolio compression and the netting of offsetting positions more challenging.
We note that the imposition of a diversification limit on UK government bonds could well force UK pension schemes towards having to use cash collateral. This would seem at odds with the original purpose of the pension scheme exemption to mandatory clearing of derivatives which was to give CCPs time to solve the technical issues associated with accepting non-cash collateral from the likes of pension schemes.
Question 2. Are there particular aspects, for instance of an operational nature, that are not addressed in an appropriate manner? If yes, please provide the rationale for the concerns and potential solutions.
As outlined under question 5, UK pension schemes are currently almost universally set up to post solely UK gilts as and when collateral is required for OTC derivatives transactions under ISDAs. These pension schemes do not hold large cash balances and hence the imposition of a diversification limit on the amount of UK gilts that can be posted will require either (i) the raising of cash using repo transactions or (ii) the separation and posting of lower quality non-government bonds.The requirement to use repo under the first option brings increased risk, such as operational risk or roll risk, to the pension scheme in question.
The second option of posting non-government bonds (typically of lower quality and liquidity than gilts) also adds risks, such as operational risk, as the non-government bonds to be posted will normally be managed by a different investment manager to the agent arranging the posting of collateral. Such arrangements are currently typically avoided at present due to the likes of operational risk should say the investment manager try to sell a specific bond at the same time as the collateral agent tries to post the specific bond as collateral. Such collateral is also less attractive due to its lower liquidity and typically lower credit quality, leading to larger haircuts.
Due to the unattractive nature of the two options outlined above pension schemes may attempt to separate legacy and new transactions. This would require the likes of two Credit Support Annexes (CSAs) with each OTC derivatives counterparty which would:
• reduce portability in counterparty failure events and make replacement of transactions more challenging going forward
• add material management and operational complexity and risk
• make portfolio compression and the netting of offsetting positions more challenging.
We note that the imposition of a diversification limit on UK government bonds could well force UK pension schemes towards having to use cash collateral. This would seem at odds with the original purpose of the pension scheme exemption to mandatory clearing of derivatives which was to give CCPs time to solve the technical issues associated with accepting non-cash collateral from the likes of pension schemes.
Question 4. In respect of the use of a counterparty IRB model, are the counterparties confident that they will be able to access sufficient information to ensure appropriate transparency and to allow them to demonstrate an adequate understanding to their supervisory authority?
NAQuestion 6. How will market participants be able to ensure the fulfilment of all the conditions for the reuse of initial margins as required in the BCBS-IOSCO framework? Can the respondents identify which companies in the EU would require reuse or re-hypothecation of collateral as an essential component of their business models?
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