EUROPE - The differences between bilateral and centrally cleared swaps under the new EMIR regulation could increase costs for pension funds, one consultant has claimed.

According to Jeremy Taylor, an operational processing and derivates specialist at consultancy Rule Financial, pension funds trading inflation swaps and interest rate swaps (IRS) as part of LDI strategies will be able to combine them into a single pool of collaterals under current credit support annex (CSA) agreements signed for OTC derivatives trades.

"Using only one pool means pension funds can post less collaterals for their derivatives trades," Taylor said.

"However, if IRS are mandated for clearing, pension funds will have to collateralise those swaps in a separate pool to inflation swaps, which will still be bilaterally traded and for which the collaterals will be held with the bilateral party."

Taylor went on to say that using a two-level approach between bilaterally traded swaps and centrally cleared traded swaps would therefore represent an additional cost burden for pension funds.

The EMIR regulation follows the agreement reached by G20 leaders in Pittsburgh on September 2009, which stipulated that all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms and cleared through central counterparties by "end-2012 at the latest".

However, the European Securities and Markets Authority has yet to determine which swap contracts should be cleared.

Meanwhile, a new analysis released by the International Swaps and Derivatives Association (ISDA) has shown that the volume of OTC trades contracted by 10.3% between June 2011 - when the OTC market stood at $440trn (€350trn) - and June this year.

The ISDA attributed the drop to the increasing use of central clearing houses and, in particular, to "compression activity" in the IRS and credit default swaps markets.

Adjusted volumes for IRS alone fell to $26trn from June last year, while the total compression of the IRS market reached $120trn on a net, cumulative basis, according to the ISDA.

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