Pension funds may abandon the use of OTC derivatives due to increasing costs and more stringent regulations, professional services firm Towers Watson said in a recently released report. These institutional investors have long used derivatives tied to inflation and interest rates to manage the risk associated with their portfolios.

On February 9, the Council of the European Union and the European Parliament voted to approve the European Market Infrastructure Regulation, which provides new laws related to the trading of OTC derivatives, according to aiCIO Magazine. The new regulations will enable various derivatives to be traded in marketplaces similar to exchanges and be cleared through central counterparties.

While some of the derivatives used by pension schemes are not yet affected by the new regulations, the financial instruments could soon fall under the new laws. OTC derivatives that do not need to be centrally cleared will require more collateral, raising costs for market participants that want to use them.

The paper also references the new capital specifications of regulators, expressing concern that the desired transactions will obligate investors to keep large amounts of cash on hand, which represents capital that could be placed into other higher-yielding assets.