ESMA recommends extension of clearing exemption

To date, pension scheme arrangements (PSAs) have been exempt from the obligation to clear OTC derivatives, which exemption currently applies until 18 June 2022. ESMA has recommended the European Commission (EC) to extend the clearing exemption for a final time to 19 June 2023.

What is it about?

Since EMIR came into effect in 2012, PSAs have benefitted from a temporary exemption from the clearing obligation which was initially set to expire in 2019, but has been renewed a number of times since. Under EMIR, the EC currently has the power to extend it by one year one last time. ESMA has now recommended the EC to exercise this power. While ESMA is of the opinion that PSAs are operationally ready and that the exemption should eventually end, it believes that PSAs and relevant market participants need time to finalise their clearing and collateral management arrangements before the clearing obligation will start to apply.

Which firms should care?

The extension of the clearing exemption is relevant to all PSAs that deal in OTC derivatives and their dealers.

What should they know?

The clearing exemption allowed PSAs time to find viable (operational) solutions to be able to meet the CCP’s cash variation margin calls, which is challenging to PSAs as they are likely to minimise their holdings of cash in order to maximise the efficiency and returns for their policy holders. The lack of operational readiness has been the primary reason for exempting PSAs from the clearing obligation.

ESMA monitors the progress that is being made by PSAs and reports to the EC on this. In its letter to the EC of 25 January 2022, ESMA finds that PSAs are now largely operationally ready, and a number of solutions exist and provide them with tools to source cash and clear their trades. This includes, for instance, (cleared) repo facilities. Therefore, ESMA is of the view that the exemption should end, but wants to provide PSAs sufficient time to (i) set up arrangements with clearing members and (ii) make adjustments to their liquidity management in order to be ready to clear the volume of contracts that would fall under the clearing obligation.

Additionally, ESMA believes that the start of the clearing obligation for PSAs should be considered in the context of the broader plan to build clearing capacity in the EU and reduce reliance on UK CCPs. According to ESMA the end of the clearing exemption can contribute to this.

When will this apply?

If the EC decides to extend the exemption, it will run until 19 June 2023. Otherwise, the exemption would lapse on 18 June 2022.

Any further thoughts?

While the EC ultimately has the discretion to extend the clearing exemption, we believe that it is highly likely that the EC will follow ESMA’s recommendation like it has before.

The probable extension would give PSAs some breathing room to prepare for clearing their OTC derivatives. It is recommended that they use this additional time to put in place the necessary clearing arrangements with clearing members and set-up the necessary facilities to be able to source cash to meet the CCP’s variation margin requirements.

The letter in which ESMA recommends the EC to extend the clearing exemption is available here.