International rules designed to make derivative transactions safer by increasing collateral requirements may lead pension plans to take unnecessary risks, according to the 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 recently release policy paper.

NAPF was responding to rules proposed by the Bank of International Settlements and the International Organization of Securities Commissions. The working group that proposed the rules includes representatives from the U.S. Federal Reserve System and the Securities and Exchange Commission. The rule would “significantly increase” the cost of hedging and, therefore, discourage it, said the NAPF.

“Pensions 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 (AIG), 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.

To contact the reporter on this story: Kevin Crowley in London at kcrowley1@bloomberg.net

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