knowledge 10 June 2015 |

Pension Scheme Arrangements - possible reprieve from EMIR Central Clearing Obligation

As set out in our web-update in February 2015, while EMIR requires standardised over-the-counter (“OTC”) derivatives to be cleared through central counterparties (“CCPs”), PSAs benefit from a three-year exemption from this requirement due to concerns about the impact it could have on retirement income.

CCPs interpose themselves between the two counterparties to a transaction and thus become a counterparty to every transaction. As such, the CCP bears counterparty credit risk in the event that one of its counterparties fails. In order to offset that risk, CCPs impose margin requirements on their counterparties, which are calculated to cover any potential losses upon a default, and generally accept only highly liquid assets, such as cash, as collateral to meet variation margin calls. However, PSAs generally minimise their cash positions, preferring to hold higher yielding but less liquid investments such as government bonds. Requiring them to clear OTC derivative contracts centrally would mean that they would have to maintain cash reserves, or put in place arrangements enabling them to generate cash at short notice, to meet CCPs’ ongoing variation margin requirements. The costs of doing so would be to the ultimate detriment of retirees.

As a result, EMIR exempts PSAs from the central clearing obligation in order to provide further time for CCPs to develop technical solutions to enable PSAs to satisfy CCPs’ variation margin requirements by the transfer of non-cash collateral. However, following a baseline study, the Commission concluded that the necessary efforts to develop such solutions had not been made and that “the adverse effect of centrally clearing derivative contracts on the retirement benefits of future pensioners remains unchanged”. Consequently, the Commission is proposing that the existing three-year exemption for PSAs from the central clearing obligation should be extended for a further two years, until 16 August 2017.  

While the current proposal is to extend the exemption by a further two-year period, it is noteworthy that the Commission has the power to extend the period by a further one-year period should the need arise.  

Next Steps

The European Parliament and the Council of the European Union now have three months in which to consider the proposed Delegated Regulation, which will enter into force if either no objection is made during that period or if, before its expiry, those institutions notify the Commission that they will not object.

As the existing exemption is due to expire on 16 August 2015, prior to the end of the three-month period, it is to be hoped that the Parliament and the Council will notify the Commission that they do not object to the proposed Delegated Regulation sooner rather than later. As observed by the Commission in the recitals to that Regulation, “[a] later entry into force could lead to legal uncertainty for [PSAs] as to whether they need to begin preparing for the upcoming clearing obligation”.