Pension funds need to prepare for margin rules covering the OTC derivatives they use.
Corporate pension fund managers may soon have initial-margin responsibilities for the over-the-counter (OTC) derivatives they use to manage those funds, even if their parent companies are exempt.
Background. Following the financial crisis, global regulators established variation and initial margin rules for OTC derivatives to provide greater transparency into counterparty risk.
- Those requirements first became effective in 2016 for financial firms with more than $3 trillion in notional derivatives exposure and were extended in stages to firms with smaller notionals, reaching those with $750 billion in exposure in 2019.
While most corporate end-users of OTC derivatives were exempted from margin requirements, their employee-benefits plans, under the Employee Retirement Income and Security Act (ERISA), were not. Consequently, most corporate pension plans will soon be subject to margin rules, and several fund managers raised issues at a recent NeuGroup meeting:
- When? The threshold for posting margin drops this year to financial end users with more than $50 billion in notional exposure, and in 2021 will include market participants with more than $8 billion in OTC notional.
- Covering margin calls. A member of the roundtable noted the need for a policy for raising cash to cover margin calls. Another participant recounted addressing that issue when her company began its overlay program, so it decided to perform a VAR analysis to size its collateral at 99% for a one-month stress test.
- “It wouldn’t have covered where we landed in the global financial crisis for equity, but for every other scenario there was sufficient cash,” she said.
- Cash or Treasuries? The participant added that her company is holding the collateral as cash, which it then “equitizes,” or places in short-term investments such as ETFs. Depending on the instrument, she said, the cash can generally also be held in Treasuries, providing a bit of income.
- Administration? No way. Tracking daily margin and posting margin is an administrative hassle, which the roundtable member said she leaves to her ERISA manager.
- “There’s no way I would ever want to do that. I just make sure there’s enough cash in the account with the manager to cover the amount of collateral we feel is sufficient,” she said.
