Pension clearing exemption- the UK takes the road less travelled

To the surprise of very few, HM Treasury (HMT) yesterday stated its intention to introduce a statutory instrument extending the exemption for pension funds from the clearing obligation by a period of two years and extending the temporary intragroup exemption regime by a further three years.

The statutory instrument will amend Article 89 (1) of UK EMIR to extend the expiry date of the pension fund exemption by two years to 18 June 2025. The instrument will also amend the relevant days set out in Articles 81(1)(b), 81(2)(b), 83(1)(b) and 83(2)(b) of The Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2019 ^{[footnote 1]}, to extend the expiry date of these intragroup exemptions by three years to 31 December 2026.

Ahead of the new 2025 pension fund exemption expiry, HMT will review the case for making the exemption permanent after consultation with industry stakeholders and taking due regard to internationally financial market fragilities and resilience in the non-banking financial sector. Apparently, reform in this area is part of the ongoing process of building a “smarter” UK financial services framework.

By contrast, the EU has run out of its legally mandated options to extend the pension fund exemption and in September 2022 confirmed its intention to apply the clearing rules from 19 June 2023. While the application of the uncleared margin rules goes some way to making the cleared vs OTC margin regimes more equivalent, some possibly consequential differences remain:

1. CCPs typically only accept cash for variation margin, the bilateral market at least has the possibility of including other assets.
2. OTC margin calls are made T+1 while CCPs may demand margin intraday.
3. There are a number of medium-size firms (ESMA estimates 31) that will be above the EUR 3bn. clearing threshold, while remaining below the EUR 8bn. OTC barrier. These firms will be subject to margin obligations for the first time.

If the factors above were to combine during a period of heightened rate volatility, it is not hard to envisage the ensuing collateral crunch. The UK’s September 2022 real-time stress test/LDI near-debacle, is only the most recent reminder of the speed with which liquidity can drain away. The EU collateral market is naturally more diverse than the UK and its pension funds rely less on LDI. However, the near-future UK-EU split in application of the clearing obligation will represent a significant differentiator between the two jurisdictions. As is to be expected, only time will tell if this divergence represents a Brexit curse or blessing.

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