Ready for a pop quiz? Don’t worry, it’s only one question and it involves pictures.
In the below, a pension fund governed under the Employee Retirement Income Security Act (Erisa) has a trading relationship with a bank. The bank, in its capacity as a Futures Commission Merchant (FCM), clears the pension fund’s trades with a clearing house, thereby shielding the fund from its own risk as a counterparty. The pension fund posts collateral to the bank/FCM with respect to its trades.
Question: What happens if the pension fund enters bankruptcy? Does the collateral go to:
A) The pensioners, of course!
B) The bank, like duh!
C) Oh man, I’m not sure…
If you answered C), that pretty much characterises what the industry is thinking right now, as reported by Matt Cameron over at Risk on Wednesday:
With nine months until they are expected to start clearing over-the-counter derivatives, corporate pension funds in the US are being rejected as clearing clients amid fears that collateral posted to their futures commission merchant (FCM) could be clawed back in the event of the fund’s bankruptcy. Bankers and fund managers are hoping for a clarifying statement from the US Department of Labor (DOL), but the hold-up is frustrating some pension plans.
“Banks have said they will not clear for us until they have received clarity from the DOL, but we want the ability to clear – especially if the European crisis hits boiling point again in the next few months. If our European swap counterparties start to look shaky, then we want to mitigate the counterparty risk through clearing,” says one fund manager.
Risk mitigation techniques being employed in the interim are rumoured to include ‘crossing fingers’ and ‘closing-i’s tightly’.
(Do head on over to Risk for more of the serious detail of the story…)
Collateral clawback fears leave US pension funds unable to clear – Risk