13 June 2017

Pension funds to benefit from further central clearing exemption

As part of proposed EMIR amendments to improve the functioning of the derivatives market in the EU, the European Commission wants to exempt pension funds from central clearing for three more years. It is difficult for certain pension funds to participate in central clearing, and the extension of the exemption period will allow market parties to develop a viable technical solution. According to the European Commission, this proposal means that additional costs of up to EUR 1.6 billion for pension funds and pensioners will be avoided.

Many pension funds enter into over-the-counter (OTC) derivative transactions to protect their pension payment liabilities against market risks. As part of central clearing, collateral must be paid to the central counterparties (CCPs) so that they can meet variation margin calls, and CCPs generally only accept cash as collateral. However, pension scheme arrangements (PSAs) tend not to hold much cash, as investments in other instruments generate higher returns for pensioners. If PSAs were forced to centrally clear, they would have to turn part of their assets into cash. This would have a negative impact on the retirement income of pensioners.

During the negotiations about the European Market Infrastructure Regulation (EMIR), the Council of the EU and the European Parliament agreed on a three-year clearing exemption for PSAs which meet certain criteria, allowing time to develop a solution. The exemption was extended for two years in June 2015 and for a further year in 2017.

The European Commission’s proposal to amend EMIR, which was published on 4 May 2017, introduces a new three-year temporary exemption. The European Commission thinks that viable technical solutions can be developed within these three years. In the event of significant unforeseen developments, the exemption may be extended once more by two years.

Despite the exemption, pension funds may still choose to participate in central clearing as they may be able to achieve better pricing on a cleared basis than on an uncleared basis for the same transaction. In that event, the pension fund may want to consider its clearing options and start negotiating the necessary arrangements for that. In addition, in a press release, the Federation of Pension Funds states that due to banking regulations, banks are increasingly only accepting cash as collateral.