The recent extension by the European Commission of the pension scheme exemption from the European Markets Infrastructure Regulation (EMIR) clearing obligation and the publication of a second consultation paper and revised draft Regulatory Technical Standards on margin requirements for non-centrally cleared derivatives (the Risk Mitigation RTS) are two key recent developments which will impact on pension schemes. The practical implications of each of those developments for pension schemes are considered in this article.*


While pension schemes generally fall within the ambit of “Financial Counterparties” (FCs) under EMIR, the European Parliament and the Council of the European Union have recognised that entities operating as pension scheme arrangements, the primary purpose of which is to provide benefits upon retirement, typically minimise their allocation to cash in order to maximise the efficiency and the return for their beneficiaries. It is specified in EMIR that “if deemed appropriate on the basis of the criteria specified in the regulatory technical standards to be developed by ESMA, [central counterparties (CCPs)] may include in the scope of the highly liquid assets accepted as collateral, at least cash, government bonds, covered bondsand where appropriate… gold”. It is therefore open to each CCP to decide as a matter of policy the collateral required by it, subject to that collateral meeting the eligibility criteria set out in the relevant regulatory technical standards. As a matter of practice, many CCPs will insist on variation margin being collateralised in cash, as it is a conduit payment, paid to the CCP by the participant with the loss-making position and paid on by the CCP to the other participant. CCPs often also require some of the initial margin payments to be made in cash. Accordingly, requiring such entities to clear over the counter (otc) derivatives centrally could potentially force trustees to divest a significant proportion of their securities for cash in order to meet the ongoing margin requirements of CCPs.

To avoid a likely negative impact of such requirements, it was agreed that the clearing obligation would not apply to certain pension schemes for an initial period of three years (i.e. up to 16 August 2015) until a suitable technical solution for the transfer of non-cash collateral as variation margin was developed by CCPs to address this problem.

On 14 July 2015, the European Council, having assessed the progress and effort made by CCPs in developing technical solutions for the transfer by pension schemes of non-cash collateral as variation margin, as well as the need for any measures to facilitate such solutions, approved a proposal to extend the exemption to 16 August 2017 on the basis that it, and the European Commission, considered that the necessary effort to develop appropriate technical solutions had not been made by CCPs, and that “the adverse effect of centrally clearing OTC derivative contracts on the retirement benefits of future pensioners [remained] unchanged” at the time the extension was granted.

The clearing exemption only applies to OTC derivative trades to which pension scheme arrangements are a counterparty in circumstances where such trades “are objectively measurable as reducing investment risks directly relating to the financial solvency of pension scheme arrangements”. Pension scheme trustees are therefore reminded that schemes should be careful when entering into OTC derivatives transactions not falling within the above category, as these may subject to the clearing  obligation.

The exemption will automatically apply to all pension schemes, except for the occupational retirement arms of life insurance undertakings, or pension schemes who are recognised under national law and whose primary purpose is to provide retirement benefits, but who fall outside the ambit of Articles 3 and 6(a) of Directive 2003/41/EC. Trustees of affected schemes should apply for an exemption from the clearing obligation after the applicable regulatory and technical standards enter into force. Once this occurs, the clearing obligation will only take effect after any relevant phase-in period, leaving sufficient time for the counterparties to apply for the exemption. The European Securities and Markets Authority (ESMA) has noted that competent authorities may facilitate the process of applications at an earlier stage where considered necessary.

IRS Clearing and Frontloading

It is important to remember that the timeline for the introduction of the clearing obligation is not yet finalised, and that each product will be subject to separate regulatory standards. So, for rate swaps (including fixed-to-float interest rate swaps, float-to-float basis swaps, forward rate agreements and overnight index swaps), it is expected at the time of writing that the applicable regulatory technical standards (IRS RTS) will enter into force in late November 2016. This clearing obligation will take effect on a phased-in basis in the three years, following the clearing obligation entering into force (see table below). To the extent that there are any further delays in the clearing obligation taking effect, the extended exemption may become of limited value.

The current projected timetable for introduction of the IRS RTS clearing obligations, and connected frontloading requirements, are set out in the table below:

Table 1

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Risk Mitigation RTS

The benefit of the clearing exemption to larger pension schemes is diminished somewhat by the impending collateral posting requirements for non-centrally cleared OTC trades. These are to be phased in from 1 September 2016.2 The rationale for the Risk Mitigation RTS is that in the absence of central clearing, the proposed collateral posting will constitute a robust risk mitigation technique to reduce counterparty credit risk in bilateral contracts.

Development of the risk management procedures and standards “to ensure the timely, accurate and appropriately segregated exchange of collateral” was delegated to the European Supervisory Authorities (ESAs) which in July 2015 closed their second consultation on the draft Risk Mitigation RTS.

One of the matters prescribed in the Risk Mitigation RTS is the amount of initial and variation margin that counterparties should post and collect and the methodologies to be used for calculating the minimum amount.

Variation margin is to be collected to cover the mark-to- market exposure of the trade. After the publication of the first draft version of the Risk Mitigation RTS, there was widespread concern that the one-business day requirement to complete the collection of margins was unfeasible because of the operational delays that, in certain circumstances, are unavoidable (in particular, time zone differences and margin call reconciliations). The revised Risk Mitigation RTS provide that variation margin shall be collected within three business days of calculation.

The amount of initial margin typically reflects the counterparty’s credit and the implied volatility commensurate with the relevant trade. Under the Risk Mitigation RTS, for initial margin, counterparties can choose between (i) a standard pre-defined schedule based on the notional value of the contract and (ii) an internal modelling approach, where the initial margin is determined based on the modelling of the exposures. The latter option allows counterparties to decide on the complexity of the model to be used. Under the Risk Mitigation RTS, initial margin will be collected within one business day of trade execution. This is something that ISDA, in its response to the consultation paper on the latest draft of the Risk Mitigation RTS, has specifically criticised.

The Risk Mitigation RTS also sets out the margin collateral eligibility criteria. One key concern with eligible collateral as far as pension schemes are concerned is the requirement that “It should be possible to liquidate assets collected as collateral for initial or variation margin in a sufficiently short time in order to protect collecting counterparties from losses on non-centrally cleared OTC derivatives contracts in the event of a counterparty default. These assets should therefore be highly liquid and should not be exposed to excessive credit, market or foreign exchange risk. To the extent that the value of the collateral is exposed to these risks, appropriately risk-sensitive haircuts  should be applied.” As discussed earlier, it is usual for CCPs to require posting of at least some of the collateral in cash, so provision in the Risk Mitigation RTS for different categories of collateral may not be very helpful as a matter of practice.

As with the clearing obligation, the standards applying to posting of collateral will be phased in over time, starting with the largest counterparties in October 20163 (albeit the implementation timetable is different for initial margin and variation margin). ESMA has explained that the proposed implementation will give more time to market participants to adapt their legal documentation, develop the necessary internal and bilateral processes and implement related operational changes.


As mentioned above, under EMIR, collateral must be segregated (operationally and legally) to ensure that collateral is available in the event of a counterparty defaulting (i.e. so that the collateral is bankruptcy remote). EMIR provides that a CCP and clearing members must offer to keep separate records and accounts for clients on both an omnibus client segregation basis (where the assets and positions of multiple clients are held together in a single account) and an individual client segregation basis (enabling the clearing member to distinguish in accounts with the CCP the assets and positions held for the account of a client from those held for the account of other clients). Omnibus client accounts may be further categorised into gross omnibus accounts and net omnibus accounts.

In opting between individual client segregation and omnibus client segregation, counterparties will need to balance the risk that assets provided by one client may be used to cover losses relating to another client (omnibus client segregation) against, for instance, the increased documentation and potential additional expense involved in entering into the tripartite arrangement with the CCP and the clearing member necessary for individual client segregation.

Under an earlier draft of the Risk Mitigation RTS, parties were required to obtain and refresh (at least annually) legal opinions on the effectiveness of the segregation arrangements: this has been replaced by a requirement to perform (at least annually) an independent legal review to determine whether the segregation requirements are met and to keep records evidencing satisfaction of the segregation requirement. While this, ostensibly, is less onerous on counterparties, it is questionable whether this gives pension scheme trustees much additional flexibility (in that an “independent legal review” may, as a matter of practice, amount to annual legal opinion updates being required).

Based on the above, it seems that the ESAs are cognisant of the particular needs of pension scheme arrangements to a degree, but it may be some time before more specific policy and standards are tailored to cater for the pensions industry.

In the meantime, pension schemes should be mindful of the current projected timeline in terms of their internal planning for EMIR:

Diagram 1

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