Falling bond liquidity and mounting cash-holding requirements will exacerbate any future liquidity crunch, according to APG and PGGM—two of Europe’s largest pension managers.
Bank capital rules—which have led several investment banks to exit bond trading—could have a wide-ranging impact on fixed income and derivatives markets, potentially leading to fire sales at times of market stress.
“It is critical for any solution to work (a) in stressed market conditions and (b) without a material adverse effect on pensioners, including disproportionate risk or cost.”Policymakers must conduct a “full analysis” of the rules’ impacts, APG CEO Eduard van Gelderen and PGGM CIO Eloy Lindeijer urged in a letter to Europe’s financial services commissioner Jonathan Hill. The letter was co-signed by Insight Investment CIO Andrew Giles and MN Services CIO Gerald Cartigny.
“At a time when regulation is expected to significantly increase the demand for cash, a shrinking repo market would reduce the supply of cash,” the signatories warned. “We are concerned the combination of the two would reduce financial stability and is likely to cause a liquidity crisis in the future.”
Derivatives trading rules introduced under the European Market Infrastructure Regulation (EMIR) will require pension funds to post cash as collateral to protect against interest rate changes. Pensions are currently exempt from the rules, but this dispensation is due to expire next year. Any derivatives trading rules for pension funds must work in periods of market stress and “without a material adverse effect on pensioners,” the organizations wrote.
“If market participants are unable to transform their high-quality securities collateral into cash quickly, cash calls on cleared and non-cleared trades may not be met, which could lead to market participants defaulting on their contracts or forced unwinds of positions at a time of market stress which would further exacerbate any crisis,” the letter stated.
The signatories also requested that policymakers allow investors to post government bonds instead of cash collateral, reducing the need for investors to liquidate holdings.
“We request that policymakers consider the impact on pension funds, and institutional investors more generally, of any proposed rules or amendments,” the letter concluded. “Pension funds and other institutional investors often bear the burden of regulatory reform as banks look to pass on any cost or risk impact to their clients. As such it is particularly important that policymakers consider the indirect impact on these institutions, and in particular on European pensioners, even in situations where these institutions are not party to the rules directly as is the case with the bank capital rules.”
Related: European Pensions Off the Hook on Derivatives Clearing & Get Your Derivatives Ready—EMIR is Here