The European Markets Infrastructure Regulation (EMIR) affects insurers that use OTC derivatives, as they will have to clear certain OTC derivative transactions and to bilaterally collateralise those that are not cleared.
How EMIR affects insurers
EMIR affects insurers that use OTC derivatives, as they will have to clear certain OTC derivative transactions and to bilaterally collateralise those that are not cleared. For cleared trades, insurers will need to post variation margin in cash, which may prove challenging. The greatest impact is likely to be on:
- annuity writers that make use of interest rate swaps
- with-profits funds that use OTC derivatives to hedge guarantees and options, and
- insurers that have defined benefit pension schemes that use OTC derivatives
Firms will also be required to have arrangements in place for reporting their derivatives transactions to TRs in line with EMIR requirements.
The proposals have implications for insurers’ OTC operations, including:
- expected reduction in counterparty credit risk
- managed counterparty default procedures for centrally cleared transactions, including replacement of derivative positions following a default event
- expected reduction in systemic risk for the financial system as a whole
- for cleared trades, initial margin will need to be posted in cash or eligible securities, while variation margin will need to be posted in cash, potentially multiple times a day
- for all derivative transactions, insurers will need to comply with transaction reporting requirements, and
- for non-cleared OTC transactions, insurers will need to comply with risk mitigation requirements including bilateral collateralisation and measures to reduce operational risk (eg, confirm details of OTC derivative trades within the timelines specified under EMIR – from 15 March 2013)
The effects of the requirement to post-variation margin in cash may be amplified for derivative contracts of a long duration and may either require insurers to hold additional liquidity in their portfolios or put in place arrangements whereby liquidity can be accessed at short notice (for example, repo arrangements).
Exemption for pensions business
EMIR is expected to exempt some market participants from certain obligations. Pension schemes and pensions business written by insurers meeting relevant criteria are exempt from the clearing obligation for a transitional period, providing time for CCPs to look into establishing a model for accepting non-cash assets as collateral to meet variation margin calls. This exemption only applies to the clearing requirements. The bilateral risk mitigation requirements will still apply for non-cleared trades. For more information on this exemption please see our EMIR notifications and exemptions page.
What you need to do
Insurers that are affected should:
- ensure that they keep abreast of the regulations and understand how their investment and risk-management processes and objectives may be affected
- start preparing for any operational changes as the requirements become clearer
- consider the impact on any new hedging strategies, rebalancing of existing hedging strategies or new products that involve the use of OTC derivatives
- keep abreast of developments in Solvency II relating to capital requirements for cleared and non-cleared derivative transactions, and
- keep abreast of the capital requirements for banks for cleared and non-cleared trades
To receive information and updates on EMIR and the notifications and exemptions, send your contact details to [email protected].