The liquidity squeeze – Volatility and margin calls impacting pension funds and energy companies
The European Parliament’s recent paper rightly calls out the similar challenges faced by pension funds and energy companies in volatile markets, where they are required to post margin on their derivatives.
The pension fund challenges were in the UK following the ill-fated “mini-budget” and were a function of rising interest rates and the fact that many pension funds (who employed LDI) had to sell their long dated gilts to fund margin calls. There’s a great explainer here from the Financial Times. This is obviously not something for EU market regulators to fix.
In the case of the energy markets, it’s very much on the EU’s radar. On 18 October 2022, the European Commission put forward a series of proposals, including a new regulation to address increasing EU gas prices and ensure security of supply. The proposals in respect of temporary joint gas purchasing, reduction of demand and price limiting mechanisms are explained in more detail in the recent insights from our Energy Group.
The proposals also included measures in respect of derivatives and trading:
- The first proposal is to increase the commodity clearing threshold from €3 billion to €4 billion, enabling energy companies to enter into more over-the-counter transactions without being subject to margin requirements. This proposal is for the benefit of non-financial counterparties only, and another review of the clearing thresholds may be forthcoming.
- The second proposal widens, on a temporary 12-month basis and subject to conditions, the list of eligible assets that can be used as collateral to meet margin calls to include public guarantees and uncollateralised bank guarantees. The measures may be extended further depending on how the energy derivative markets function over the coming months.
The Commission has also proposed a temporary measure to manage excess price volatility in the gas and electricity derivative markets by introducing a new intra-day price volatility management mechanism for trading venues. The technical aspects of the mechanism will be set out in implementing legislation from the Commission. The new temporary measure won’t preclude trading venues from applying further contract-specific volatility limits.
ESMA and the EU Agency for the Cooperation of Energy Regulators (ACER) have also announced enhanced cooperation (by way of a soon-to-be-established joint Task Force) to further improve information exchange and avoid potential market abuse in Europe’s spot and derivative markets.
A busy couple of weeks from an EMIR/derivatives perspective has also seen the Commission adopt two amending Delegated Regulations that extend the temporary exemptions regime for intragroup contracts for three years under EMIR. Until those amending Delegated Regulations are published in the Official Journal, ESMA’s 13 June 2022 ‘no action’ letter continues to apply.
The output from the Commission’s EMIR review is also due in December 2022.
To discuss any of the above in more detail, please get in touch with Phil Cody of our Derivatives, Treasury and Market Infrastructure Group.