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 Trusts database. To determine the impact of Dodd-Franks 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.
In addition to initial margin requirements for interest rate swaps, the Northern Trust paper examines requirements for variation margin for interest rate swaps, credit default swaps and uncleared swaps under the new regulations. The paper and more information on methodology can be found online at Northern Trusts Insights and Research page.
"This research can serve as a reality check for plan sponsors and pension fund investors confronting the new regulatory environment for derivatives," said Peter Cherecwich, Head of Global Fund Services at Northern Trust. "While our research indicates that plans have adequate collateral for a large portion of their current investment strategies, however, cash and collateral management will pose a real challenge under the new regulations. We are committed to helping our clients navigate these changes, with both research and expanded services, in the years ahead."
Northern Trust offers an active collateral management service for clients that trade futures and listed options, OTC derivatives and cleared swaps. Northern Trust provides this service for an array of derivative participants including asset managers, corporations, pension funds and family offices located around the globe. In addition, Northern Trust will continue to invest in operational capabilities in support of margin management to help clients optimize their pledged assets.
About Northern Trust
Northern Trust Corporation (Nasdaq: NTRS) is a leading provider of investment management, asset and fund administration, banking solutions and fiduciary services for corporations, institutions and affluent individuals worldwide. Northern Trust, a financial holding company based in Chicago, has offices in 18 U.S. states and 17 international locations in North America, Europe, the Middle East and the Asia-Pacific region. As of June 30, 2013, Northern Trust had assets under custody of US$5 trillion, and assets under investment management of US$803 billion. For more than 120 years, Northern Trust has earned distinction as an industry leader in combining exceptional service and expertise with innovative products and technology. For more information, visit www.northerntrust.com or follow us on Twitter @NorthernTrust.
Northern Trust Corporation, Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A., incorporated with limited liability in the U.S. Global legal and regulatory information can be found at http://www.northerntrust.com/disclosures