Pension funds and other financial institutions look set for potential reprieve from strict enforcement of new derivatives rules following an announcement by the European Supervisory Authorities (ESAs) yesterday.

The statement concerns a 1 March deadline for rules requiring variation margin to be posted as collateral to cover counterparty risk in non-cleared, over-the-counter (OTC) derivatives.

In a joint statement, the ESAs* said they “have been made aware of operational challenges” in meeting the deadline. Although they did not explicitly refer to small pension funds, they noted that smaller counterparties in particular were having difficulties.

They effectively granted national regulators discretion not to strictly enforce compliance with the new rules, saying that they can assess “the degree of compliance and progress” on a case-by-case basis.

“This approach does not entail a general forbearance,” they said.

To meet the new rules pension funds and other institutions have to update legal documentation such as credit support annexes (CSAs), contracts covering derivatives arrangements between counterparties. There are thousands of such documents in existence covering derivatives trades in funds and liability-driven investment strategies.

PensionsEurope welcomed the announcement by the ESAs, saying that getting the documentation in place by the March deadline was “a significant challenge” and that pension funds and their service providers in many countries were struggling to do so.

Úrsula Bordas, policy advisor at the trade association, said: “A strict interpretation of the compliance rule would mean that many pension funds would have a limited access to liquidity as they would have a limited number of banks with whom to trade and this could significantly impact their ability to hedge risks.”

PensionsEurope “hopes national authorities will further explain their approach to compliance for the next months to pension funds and their service providers”, she added.

A head of clearing at a European bank told IPE that, if a pension fund or any other financial institution was not able to get new CSAs in place in time, “it looks as though [it] will be left up to individual counterparties to decide if they want to cease trading, and how forgiving their supervisor will be if they don’t”.

The picture was mixed as to how supervisors would proceed, and some sort of materiality would be considered, the banker added.

The ESAs said national regulators should “take into account the size of the exposure to the counterparty plus its default risk” when making enforcement decisions. The UK regulator set out its approach to enforcement, or “supervision of firms’ progress”, in a statement yesterday.

The banker cited an expectation that, at best, 50% of agreements will be re-negotiated and in place by the March deadline, leaving “a significant gap still to be re-negotiated”.

The ESAs did not hide their displeasure at having to make yesterday’s announcement, noting that “[t]he timeline for implementation has been known in EU since 2015, and it is unfortunate that the financial industry has not managed to prepare for the implementation”.

“Furthermore, a delay of 9 months was already granted by BSBC-IOSCO in 2015 on the basis of similar arguments from the industry,” they added. “That delay was agreed with the clear expectation that the financial industry would be ready to prepare the implementation within two years.”

The ESAs’ announcement comes after the US derivatives regulator earlier this month issued a “no action” letter, providing a grace period on the collateral rule. In their statement, the ESAs noted that they have no mandate to disapply directly applicable EU law.

US regulators and IOSCO, the international umbrella organisation for securities regulators, also made announcements yesterday acknowledging that industry may not be able to complete the necessary documentation to be able to fully comply with the variation margin requirements by the scheduled deadline of 1 March. Both agreed that there should be some leeway.

Pension funds recently obtained an extension of their exemption from a requirement to centrally clear OTC derivatives, with this now lasting until August 2018. 


*The European Insurance and Occupational Pensions Authority (EIOPA), European Securities and Markets Authority (ESMA), and European Banking Authority (EBA)