Pension funds should have adequate capital to cover new requirements imposed on the bulk of over-the-counter (OTC) derivatives trading by the Dodd-Frank Act, according to a new white paper by Northern Trust.
The research paper, “ Capital Requirements for Pension Funds in the Wake of Dodd- Frank,” is based on a review of current pension fund information in Northern Trust’s database. To determine the impact of Dodd-Frank’s initial margin requirements on pension funds, Northern Trust identified the requirements across more than 200 accounts holding eligible interest-rate swap products. The analysis showed that most funds in the sample group with margin requirements of more than $1 million had ample eligible collateral, in the form of high-grade government or corporate bonds, to meet their initial margin requirements.
"New capital requirements associated with the central clearing of formerly OTC derivatives can seem imposing, but it appears some early estimates were overly negative regarding the ability of pension funds to handle the Dodd-Frank margin requirements,” said Judson Baker, Product Manager for Derivatives and Collateral Management at Northern Trust. "Our research on a significant sample of clients shows that most pension funds should not be deterred from their current trading strategies as they are prepared to handle capital adequacy requirements."
In an effort to reduce risk and increase transparency, the Dodd-Frank Act imposes mandatory clearing and trade execution of certain products in the $633 trillion OTC derivatives market. Implementation of central clearing is occurring in phases, with pension plans required to move certain interest rate and credit default swaps to central clearing platforms on September 9, 2013. Interest rate derivatives account for approximately 77 percent of total swap activity in the global OTC market and the products are widely used by pension funds in liability-driven investment strategies to extend portfolio duration and hedge long-term pension liabilities.