The Society of Pension Professionals (SPP) and the Association of Consulting Actuaries (ACA) have called for pension funds to be exempt from clearing derivatives contracts.
UK pension funds are currently exempt from clearing derivatives contracts used to hedge risks that directly relate to their financial solvency – for example, where they use derivatives to hedge against interest rate and inflation movements to ensure that they can meet their obligations to their members.
In March 2023, the UK government extended the exemption until June 2025. In November, the HM Treasury issued a consultation seeking input from industry stakeholders on pension funds’ exemption from the clearing obligation to inform the government’s long-term approach.
The consultation, which closed on 5 January, sought views on hedging and use of the exemption; bilateral markets and particularly how firms currently use these markets and what potential benefits they provide compared to clearing; facilitating clearing and meeting variation margin requirements; the autumn 2022 LDI crisis; and the impact of the expiry of the exemption.
SPP said in its response to the consultation that UK defined benefit (DB) pension schemes are “broadly in excellent health” and their use of derivatives to increase the link between asset and liability values has played a significant role in their progress.
It added that the presence of these derivatives within portfolios allows schemes to prudently manage risk and to allocate to return-seeking assets.
SPP added that trustees currently have a choice as to whether to centrally clear or use bilateral agreements. It said that this choice is beneficial and allows schemes to make the best choices for their schemes’ circumstances.
Therefore, SPP said the exemption for UK pension schemes from clearing should be retained and, ideally, made permanent.
It explained: “Mandating clearing for all transactions would introduce significant costs and risks for pension schemes and financial stability as a whole with no clear benefits.”
ACA’s response to the consultation focused on derivatives used for liability hedging purposes only. Similarly to SPP, ACA said that the pension fund exemption should not be allowed to expire, and that very careful consideration would need to be made if the exemption is to be removed.
Vanessa Hodge, chair of the ACA’s investment committee, also agreed with SPP that if the exemption was to expire then it is likely to create operational burdens and bottlenecks to implement.
She said that on balance, it will bring more costs than benefits.
“In particular, it is likely to lead on average to pension schemes needing to hold more instantly available cash. The consequence of which could be for some schemes increased liability risk or a requirement to target lower returns, both of which could be negative for members and in particular sponsors who will see the volatility of contributions increased and/or the pound amount of contributions increased,” Hodge noted.