New US legislation1 could weaken protections for money market funds in which UK pension funds invest. This legislation also provides a pointer as to how changes in UK and EU law may affect investment in swaps. These changes are not yet in force and the detail is still being worked on, but trustees may wish to ask their investment consultants how they view them.

Money market funds

UK pension funds often invest in money-market funds - usually based in Ireland – as an alternative to bank deposits. These money market funds are managed consistently with US legislation2 which includes the use of credit ratings. In the financial crisis managers of several money market funds had to commit to paying money into them to keep them solvent, because they had invested in asset-backed securities on the basis of credit ratings. Within two years, the US legislation will remove credit ratings as a requirement in deciding credit quality and the rules for Irish money market funds may be similarly amended. An unintended result of this could be to make money market funds less secure. 

Also the US legislation may possibly end up preventing some US fund groups from paying money into such funds to ensure that they remain solvent.

Derivatives clearing

The US legislation will also require standardisation of swap contracts (subject to certain exceptions). The EU’s own proposals due to be published in September may follow the US approach. Many swaps used by pension funds will not lend themselves to this standardisation. The US legislation will not apply to UK pension funds entering into swaps with investment banks in London. However it may indicate how UK and EU law could change. Concerns are that compulsory standardisation will inhibit innovation and the changes could make it more expensive for pension funds to hedge risks and may require them to hold cash for posting as collateral instead of government bonds.