The Pension Fund clearing exemption has not been extended, Jo Burnham investigates what this means for funds and why firms need to act now.
The prospect of central clearing has been hanging over the heads of Pension Funds for a long time. The obligation to clear start date has been extended multiple times, on top of exemptions which have been extended twice. However, the last of these exemptions is set to expire on 17 August 2018, and under EMIR it’s not possible to extend this any further.
Yet, everyone recognises that the market is not yet ready for Pension Funds to begin central clearing because:
There is a lack of clearing members willing or able to provide clearing services at fair and reasonable commercial terms.
The market has not yet implemented solutions to allow the transfer of non-cash collateral as variation margin.
This would appear to be an impossible problem to solve, but luckily this potential issue was spotted last year, and as part of the European Commission’s Regulatory Fitness and Performance programme (REFIT) changes were proposed to EMIR to allow ESMA to request an exemption from clearing in just these circumstances.
The only problem is, although this proposal was made in May 2017, it still hasn’t been ratified. This means – in theory – Pension Funds will be obliged to start centrally clearing on 17 August, only to be granted an exemption very soon afterwards when the proposal is ratified by the European Parliament.
A statement from ESMA on 3 July made it clear they are aware of this bizarre situation. In their closing paragraph they state:
‘ESMA expects competent authorities to not prioritise their supervisory actions towards entities that are expected to be exempted again in a relatively short period of time’.
ESMA are in effect telling the regulators to ‘turn a blind eye’!
Pension Funds will be relieved that they will not be obliged to begin clearing on 17 August, even if there’s no official exemption. But the bigger question is: when will the central clearing obligation actually begin?
In a speech by Vice-President Dombrovskis on 4 May 2017 on the EMIR REFIT, it was stated: “We are providing three years to develop technical solutions for pension funds to take part in central clearing”. This could imply a start date of May 2020.
On the other hand, in his opening remarks to the European Parliament Plenary debate on 11 June 2018 on the same subject, Dombrovskis said: “We still need this exemption for a short time” and that “Progress during this extended exemption period must be monitored”. This implies they would want to introduce the clearing obligation sooner rather than later, and not wait until 2020.
The other regulatory issue for Pension Funds to consider is Uncleared Initial Margin Rules. This regulation is being slowly staggered in, with the final date for full compliance being September 2020. And no exemption to this regulation is likely. So, Pension Funds will ultimately need to post both Initial and Variation Margin by autumn 2020 – a date which is rapidly approaching.
Whether it be the introduction of the clearing obligation or the requirement to post Initial Margin on a bilateral portfolio, the costs need to be understood and tools put in place to validate and monitor change in Initial Margin soon. So, Pension Funds need to act now in order to be on the right side of regulators and remain competitive – many big firms are already clearing as much as possible.