Derivative Laws May Push Pensions to Take More Risk, NAPF Says

International rules designed to make derivative transactions safer by increasing collateral requirements may lead pension plans to take unnecessary risks, according to the U.K.’s National Association of Pension Funds.

Higher costs associated with derivative trades through increasing margin requirements could make pension funds abandon hedging strategies, making their assets more susceptible to moves in inflation and interest rates, the London-based NAPF said in a policy paper dated March 15.

“Pension schemes use derivatives largely to hedge liabilities and, thereby, reduce risk,” according to the paper. “Extra costs or processes that provide a disincentive for pension schemes to use derivatives could, in fact, increase the degree of risk in the markets.”

Global regulators have sought tougher rules for derivatives since the 2008 collapse of Lehman Brothers Holdings Inc. and the U.S. government rescue of American International Group Inc., two of the largest traders in credit-default swaps. The plans include pushing more transactions through clearing houses and raising collateral requirements to cut complexity and risk.

Derivatives are “used extensively” among pension funds to mitigate risk, and trades have a “long-term tenure” that don’t seek to profit, said the NAPF, which represents U.K. pension plans with 1 trillion euros ($1.29 trillion) of assets. About 57 percent of the NAPF’s 1,200 members use derivatives, mainly to hedge against interest rates and inflation, it said.

The new rules, proposed by the Bank of International Settlements and the International Organization of Securities Commissions, would “significantly increase” the cost of hedging and, therefore, discourage it, said the NAPF, which was responding to the proposals.