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UK Pensions speedbrief : Are you complying with the new regulatory requirements that apply to derivatives held by pension plans and common investment funds?

    • Financial services and markets regulation - EMIR
    • Pensions

    29-01-2014

    New regulatory requirements applicable to derivatives transactions entered into by pension plans and common investment funds are now in force. These requirements, under the European Market Infrastructure Regulation (“EMIR”), mean that trustees need to:

    • put in place risk mitigation measures in respect of all so-called ‘over-the-counter’ (OTC) derivative transactions
    • comply with new derivative reporting requirements from 12 February 2014 for both OTC and exchange-traded derivatives
    • decide whether to clear derivative transactions when the new clearing requirements come into force (which is expected to be later this year)
    • update their investment management agreements and ISDA contracts where the EMIR regulatory requirements are to be met by their investment manager or a counterparty, and
      update their risk register and governance processes to cover these new regulatory requirements.

    This e-briefing summarises the EMIR regulatory requirements and outlines what they mean for pension plans and common investment funds. It also contains links to more detailed summaries of:

    • the risk mitigation measures that trustees should already be putting in place in respect of their OTC derivative transactions Read more
    • the new reporting requirements relating to OTC and exchange-traded derivatives that come into force on 12 February 2014 Read more, and
    • factors to consider when pension plans and common investment funds decide whether they should clear their derivatives transactions through a clearing house Read more.

    What are derivatives?

    In the pensions context, a derivative is a financial instrument entered into between trustees and a counterparty, the value of which is derived from an underlying asset or index and under which certain payments are made between the parties based on the value of the underlying asset or index such as interest or inflation rates, stock market indices or longevity statistics.

    Derivatives are either:

    • privately traded, bi-lateral contracts which are agreed “over-the-counter” (“OTC”) between the parties without going through an exchange or intermediary; or
    • traded on an exchange.
    • Most pension plans are likely to have entered into derivative transactions, for example, to hedge their exposure to foreign exchange rates or to interest rates. If you are in any doubt, you should check this with your investment manager.

    What is EMIR?

    EMIR is one part of a range of EU legislation that is being enacted with the aim of ensuring that key risks within the financial system are as transparent as possible to reduce the likelihood of a future financial crisis.

    EMIR came into force on 16 August 2012. However, the various requirements contained in EMIR are being phased in over time. These requirements include:

    • Risk mitigation requirements for uncleared OTC derivatives transactions – these requirements came into force during March and September last year and already apply to pension plans and common investment funds.
    • New reporting requirements relating to both OTC and exchange-traded derivatives transactions – these requirements apply from 12 February 2014.
    • A requirement to clear certain derivatives transactions – the core obligation to clear OTC derivatives transactions is likely to come into force during this year, albeit pension plans have a three year transitional period (from 16 August 2012) during which they need not clear their transactions. However, for a variety of reasons (including pricing), many pension plans intend to clear their transactions before the end of the transitional period.

    What does EMIR mean for pension plans and common investment funds?

    1. Trustees of pension plans and common investment funds need to do five key things in relation to EMIR:

    - Put in place “risk mitigation” measures in relation to uncleared OTC derivatives – This requirement is already in force and it applies to all uncleared OTC derivatives transactions. Risk mitigation measures include:

    - confirming derivatives transactions in writing with the counterparty,

    - undertaking portfolio reconciliation (which involves both parties to a transaction reconciling key trade information on their records),

    - undertaking portfolio compression (i.e. where appropriate, reducing the number of transactions the pension plan has with a single counterparty),

    - putting in place a dispute resolution procedure, including reporting disputes over a certain value that are not resolved after 15 days to the competent regulator (e.g. the - Financial Conduct Authority (“FCA”)); and

    - marking to market derivative transactions on a daily basis and, where this is not possible, marking to a model.

    Some of these practical measures might be delegated to the relevant fund manager via an amendment to the Investment Management Agreement (although the ultimate liability remains with the trustees). The fund manager would then need to make appropriate changes to the ISDAs it enters into as the trustees’ agent. Read more

    2. Be ready to comply with new reporting requirements with effect from 12 February 2014 – This includes a requirement to report all new derivative transactions entered into on or after 12 February 2014 to a so-called “trade repository” within one working day. Many derivatives transactions entered into before 12 February 2014 will also need to be reported. Read more

    3. Decide whether to clear derivative trades via a central counterparty – This requirement is expected to come into force later this year. Pension plans have a transitional period of 3 years from 16 August 2012 before they are required to clear. However:

    trustees may want to clear derivatives transactions even before they are required to do so, for a variety of reasons, including because uncleared derivatives are likely to become more expensive; and

    there is a question over whether the transitional period applies to common investment funds

    4. Update their investment management agreements and ISDA contracts – Trustees will want to delegate compliance with some of the EMIR regulatory requirements to their investment managers and/or a counterparty. Investment management agreements and ISDA contracts should be updated to reflect this.

    5. Update their pension plan’s risk register and governance processes to cover these new requirements.

    Failure to comply

    EMIR requires that member states introduce penalties for breaches of EMIR. In the UK, the FCA has been given power to require the provision of information and to impose penalties for breaches in an amount it considers appropriate.

    How we can help

    • Eversheds’ pensions and derivatives teams are working together to advise on the pensions implications of the regulatory requirements under EMIR. This includes advising on:
    • the implications of EMIR for pension plans and common investment funds,
    • what trustees need to do to comply, and
    • updating documentation with investment managers and counterparties to ensure compliance.
    • Auto-enrolment and HR - Compliance, communication and implementation
    • Pensions: key trustee and employer responsibilities

    For more information contact

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