PensionsEurope has proposed to the European Commission (EC) that European central clearing houses (CCPs) could provide central bank liquidity to pension scheme arrangements (PSAs) in times of stress, to convert high-quality government bonds into cash.

The proposal was made in response to the EC’s consultation on the review of the central clearing framework in the European Union. PSAs will soon be required to clear only with EU CCPs. PensionsEurope, which has welcomed the review, believes the best way forward is a structural solution, involving central bank liquidity, as central clearing houses in Europe would suffice to provide (indirect) central bank liquidity utilizing their cleared repo platform.

The association explained that the main concerns to PSAs to fully switch to clear only with the EU CCPs include the costs related to switching exposures and transition risks. Switching exposures can be costly, as the exposures in UK CCPs have different market values than in the EU CCPs, the association explained.

In addition, PSAs in Europe have an exemption to clearing until 18 June 2022 because of the liquidity risks arising from margin calls for cleared transactions. The key challenge for PSAs is the need to post variation margin in cash in case of market stress when they may be required by CCPs to post significant amounts of variation margin, PensionsEurope explained.

Although the association is supportive of its intention to clear all derivatives possible, it agrees with the recent European Securities and Markets Authority (ESMA) advice to the commission that an extension of PSAs’ exemption from clearing obligation until 19 June 2023 is still needed.

PensionsEurope said that several leading investment banks do have proposed liquidity arrangements to PSAs as a solution to their liquidity risk (large variation margin calls). However, these arrangements tend to be complex, expensive, and only for limited capacity. Most importantly, they are much smaller than the demand from PSAs.

“Furthermore, we do not believe they really work during times of stress when PSAs need them. This holds true also for PSAs that are not directly or legally affected because the advantage of a clearing exemption does not ‘reach them’ if the collateral management is done via an (100 per cent self-owned) investment vehicles or investment funds,” PensionsEurope stated.

Therefore, the association has proposed a solution that would see European CCPs provide central bank liquidity to PSAs in times of stress to convert high-quality government bonds into cash.

“From a risk management perspective, the European clearing houses would become then the superior platform to clear derivatives transactions for PSAs. Currently, UK clearing houses and EU clearing houses are similar from a risk management perspective. We are not asking for direct liquidity, just mere (temporary) collateral transformation of (European) government bonds into cash (which are better match for pension funds liabilities than cash),” PensionsEurope concluded.

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