There are various types of private social security funds (фондове за социално осигуряване) under Bulgarian law depending on the social security risks they cover. However, as the regime for derivatives and repo transactions is identical for all types of funds, no differentiation is necessary for the purposes of this paper. The term "Pension Funds" as used here thus covers all social security funds under the Bulgarian Social Security Code [Кодекс за социалното осигуряване] (the Code).
Certain amendments to the Code which will enter into force on 18 November 2018 will change the regime for derivatives and repo transactions with Bulgarian Pension Funds (1), and these will be briefly outlined below.
Existing legal framework and problems underlying repo transactions
So far there have been only two statutory restrictions on repo transactions with Pension Funds (Repos). Firstly, as Pension Funds' assets may only be invested in certain types of securities expressly listed in the Code, Repos must be for such securities only. Secondly, there is a quantitative restriction whereby Repos under the preceding sentence may be for up to 5 % of the Pension Funds' assets.
The Financial Supervision Commission (FSC), which is the authority supervising Pension Funds' activities in Bulgaria, attempted to impose certain additional restrictions to avoid the risks that Repos be used to provide long-term credits. In this respect, it published some guidelines requiring inter alia that the relevant agreement for Repos be for a period not exceeding six months. In practice, however, many Repos were entered with tacit prolongation clauses for additional six-month periods, after the expiry of each preceding six-month period. The FSC used to impose administrative penalties for such arrangements, which were normally successfully appealed before the courts. There have been more than 20 final publicly available judgments in the last couple of years repealing such penalties, arguing that the FSC had no legal power to impose additional requirements on Repos apart from those imposed under the Code.
The new framework for Repos applicable as of 18 November 2018
Under the 18 November 2018 amendments to the Code, apart from the two statutory restrictions above, Repos should comply with four additional requirements. Firstly, counterparties to Repos may only be credit institutions or investment firms with capital exceeding certain thresholds, licensed in an EEA or OECD Member State. Secondly, Repos should be for not more than six months. Thirdly, the possibility to enter into Repos must be provided for under each Pension Fund's investment policy [инвестиционна политика], the mandatory requisites of which are set out in Regulation No. 56 of the FSC. Fourthly, the Repos should comply with the investment purposes and restrictions under the investment policy of each Pension Fund.
Apart from the six-month temporary restriction and the restrictions on the types of counterparties, which may be easily monitored and verified, counterparties to Pension Funds under Repos would be well-advised to make certain checks and have in place certain representations in the Repos documentation to cover the remaining restrictions.
New derivative risks mitigation instruments available to Pension Funds
To reduce investment risks associated with Pension Funds' assets, certain transactions exhaustively listed in the Code may be used, whereby performance of the respective obligations is delayed. So far only three types of transactions were permitted: (i) deals in futures or options traded on EEA Member States' regulated markets, or other markets as specified by the FSC; (ii) foreign currency forwards (FX forwards); and (iii) interest rate swaps (IR swaps). Under the 18 November 2018 amendments to the Code, Pension Funds will also be allowed to be parties to a fourth category of risk mitigation deals: over-the-counter options (2) (OTC Options), where the counterparty is a bank supervised in an EEA Member State or in another country as specified by the FSC.
New rules for the terms and obligations with respect to derivative risk mitigation instruments
The detailed terms (including some restrictions in addition to those under the Code) for entering into risk mitigation transactions and the ongoing regulatory obligations thereof are set out in detail in Regulation No. 34 of the FSC, which has been extensively amended alongside the Code, where most of the amendments will enter into force on 19 November 2018, i.e. immediately after the amendments to the Code discussed here.
Certain restrictive rules under Regulation No. 34 applicable to IR swaps and FX forwards do not apply to the new type of derivatives that Pension Funds may use under the Code: OTC Options. In particular, Pension Funds' counterparties to IR swaps and FX forwards may be credit institutions and investment firms with a credit rating of BB/Ba2 or higher. As this restriction is not expressly applicable to OTC Options, it seems that even banks with a rating lower than BB/Ba2 may be counterparties to a Pension Fund under OTC Options.
(1) Pension Funds are legal persons, but their activities are exclusively managed by pension security companies that are separate legal entities (Pension Companies). So, both repos and derivatives may be executed only by Pension Companies acting on behalf of and for the account of Pension Funds. Banks therefore would be well-advised to make it clear that their counterparty is the respective Pension Fund, e.g. by reproducing in the documentation the statutory wording so that the Pension Company is expressly stated as executing the transaction "on behalf of and for the account of" a Pension Fund.
(2) The options (as well as the futures, referred to above) must be with respect to those securities as listed in the Code where the Pension Funds' assets may be invested.
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