Pension funds press for central bank repo backstop

Bank of England support seen as 'only' option to ease collateral fears

The Bank of England

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Pension funds are pressing the Bank of England (BoE) to act as a liquidity provider of last resort in times of stress, to help address fears about the impact of clearing regulation on the sector.

Speaking on a panel at a Risk conference in London on October 6, David Cobbald, portfolio manager at the UK's Pension Protection Fund, said his and other organisations had spoken with the BoE about how it might help pension funds should they face heavy collateral demands during times of stress.

"Why can the central bank not be the [source of] liquidity of last resort?" he told delegates. "They're certainly not discounting it as a prospect."

The move to central clearing of over-the-counter derivatives under the European Market Infrastructure Regulation (Emir) will force pension funds to hold cash to post as variation margin, dragging down yields on their asset portfolio. Funds worry that interest rate and inflation hedges that typically are now in the money but will move out of the money when rates rise, will lead to big margin calls across the sector.

Although pension funds are exempted from Emir's central clearing requirement until August 2017, with the option of a further extension until August 2018, there is some doubt the repo market would be able to handle their collateral transformation needs should rates rise.

I can imagine it's a difficult solution, but I think it's the only one

Funds want the BoE to provide a means for them to upgrade assets if they come under pressure to source collateral. Last year the bank opened access to its discount window to central counterparties and broker dealers.

"If you look at some statistics of the amount of collateral we could be called to post, it runs into the hundreds of billions for a 1% rate rise," Cobbald said. "We have a large demand and this is not going to be satisfied by banks. We've also seen a very large cost increase across the board and I think that's going to get larger, to be honest."

Also on the panel, Anja Kleefsman, treasury investment manager for pensions administrator PGGM Investments, based in the Netherlands, agreed. "I can imagine it's a difficult solution, but I think it's the only one."

However, Max Verheijen, managing director at pensions consulting firm Cardano, questioned whether periods of stress in the markets would coincide with pension funds having to post more collateral.

"In stressed times maybe the repo market will dry up," he said. "But pension funds will be stressed when rates go up. If rates are 3% again in the euro area, or 4% or 5% in the UK, that means we have growth. We would need cash or collateral, but that's not a stressed situation. In a real stress [when rates are falling] we would receive more and more collateral."

He also suggested pension funds might look beyond the repo market for collateral transformation and try to access corporate cash pools. Other panellists, though, expressed concerns that such a market would also dry up in times of stress.

Meanwhile, any rising price differential between cleared and uncleared trades as other market participants move to central clearing could force pension funds into central clearing, panellists said.

Fiona Southall, senior solutions strategist at Axa Investment Management, noted that Axa was already seeing pricing differences, and the speakers all agreed that the costs of bilateral trades would most likely rise, potentially causing funds to move into central clearing regardless of the exemption.