The new European derivatives regulation (EMIR) will require certain counterparties to OTC derivatives not cleared through a central counterparty to put in place new collateral arrangements. The EC adopted the draft regulatory technical standards (RTS), which implement the collateral obligation, on 4 October 2016. The Council of the EU and the European Parliament must now consider the draft RTS. If there are no objections, then the draft RTS could come into force during the course of January 2017.
What do pension schemes need to do?
Like others in the market, pension schemes will need to ensure their derivatives documentation is updated to comply with the new collateral rules. A pension scheme can do this either:
- on a bilateral basis using the new ISDA form of Credit Support Annex; or
- by adhering to the ISDA Variation Margin Protocol (the “Protocol”), which will be available via an online platform.
For bilateral derivatives relationships, the responsibility to comply rests with the pension scheme. If a pension scheme employs an investment manager, the investment management agreement may provide that compliance is an obligation of the investment manager, but the ultimate statutory responsibility will still rest with the pension scheme.
What are the issues?
A “one size fits all” approach to derivatives documentation will not work for all pension schemes. Bank counterparties with thousands of agreements may prefer to update agreements using the Protocol, which gives little room for negotiation.
The standard updates provided by the Protocol may override important provisions that pension schemes have negotiated into their derivatives documentation, raising separate legal issues that are particular to pension schemes.
There are also separate issues that arise where pension schemes have more than one investment manager.
Investment management agreements often give investment managers a right to update derivatives documentation on behalf of pension scheme clients (including entry into the Protocol), but if this is done improperly, the legal liability may rest with the pension scheme.
What to do now?
Pension schemes should be looking at their investment management agreements and underlying derivatives documentation to determine what approach to updating their documentation is most appropriate. Given the large number of agreements in the market that need to be updated by the 1 March 2017 deadline (and the expected capacity restrictions of counterparties to negotiate new documentation as this deadline draws nearer) this work should be started as soon as possible.