The Investment Management Association (IMA) has responded to the European Supervisory Authorities’ (ESA) Joint Discussion Paper on risk mitigation techniques for non-cleared OTC derivatives.

The IMA expresses concern that the ESA’s proposed approach could substantially increase costs for pension and UCITS funds, thus impacting investment returns for unit and policy holders.

The ESAs have suggested that bilateral (non-cleared) trades should be subject to the provision of initial margin. Currently UCITS funds and pension funds do not provide initial margin for their bilateral trades with banks, instead exchanging appropriate collateral with the banks to support their trades. The arrangements are different for trades which are centrally cleared, where initial margin provides an additional pool of resource for clearing houses to draw on in the event of rapid movements in the market or a market default. Central clearing houses assess initial margin requirements based on product and market risk. By contrast bilateral trades also assess individual counterparty risk, an important element which cannot be reflected in initial margin.

Requiring initial margin for bilateral trades will force funds to invest in a narrower group of assets to meet eligible collateral requirements, which generally will provide lower returns. If an initial margin requirement were to be introduced, the list of eligible collateral assets would need to be extended. Otherwise funds would be unreasonably restricted in their investment options.

Jane Lowe, IMA director of markets, said: “The proposals are wrongly focused on the requirement to post initial margin, without taking into account the cost to end investors. They also do not appropriately draw out the critical element of counterparty risk.

“The proposals as presented could provide a disincentive for pension funds and UCITS to manage their investment and liability risks.”