Draft Pension Fund Clearing Obligation Exemption (Amendment) Regulations 2025
(1 day, 22 hours ago)
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The Economic Secretary to the Treasury (Emma Reynolds)
I beg to move,
That the Committee has considered the draft Pension Fund Clearing Obligation Exemption (Amendment) Regulations 2025.
It is a pleasure to serve under your chairmanship, Mr Betts. The draft regulations will remove the time limit on the temporary exemption that pension funds have from clearing over-the-counter derivatives contracts, such as interest rate swaps, through a central counterparty. The exemption will continue indefinitely, ending the need for the Government to renew it every two years if they conclude that it is necessary.
The draft regulations will help UK pensioners by supporting pension funds’ ability to invest in assets that generate returns for their benefit. Maintaining the exemption is also in line with the Government’s priorities to increase productive investment by pension funds to support economic growth.
Central counterparties are a type of financial market infrastructure that firms use to reduce risks when trading on financial markets. They sit between the buyers and sellers of financial instruments, providing assurance that contractual obligations will be fulfilled. They do so by collecting collateral, known as margin, from all their users, which can be used to cover any shortfall if a default occurs. The process of transacting through a CCP is known as clearing.
In 2009, G20 countries agreed that certain standard derivatives contracts should be cleared through CCPs to reduce risks in the financial system. In the EU, this was implemented through legislation and is known as the clearing obligation. At the time, it was decided that pension funds should be exempted from the obligation because of the particular challenges that pension funds would face in meeting CCP margin requirements.
CCPs require certain types of margin to be posted in cash. Pension funds do not usually hold large cash reserves, as they invest a large majority of their resources in assets such as gilts and corporate bonds to provide returns for pension holders, meaning that meeting the requirement to post margin in cash can be more difficult for pension funds than for other firms. Requiring pension funds to clear their derivatives could cause them to increase their cash holdings, reducing their investment in other assets and their ability to generate returns for future pensioners over the longer term.
The UK assimilated the clearing obligation and the exemption into UK domestic law through the European Union (Withdrawal) Act 2018, which was passed under the previous Government. The exemption was initially designed as a temporary measure, but it has since been extended several times. At present, the Government need to lay secondary legislation every two years if they conclude that it is necessary to extend the exemption. The most recent extension was in June 2023, under the previous Government, who noted that
“it would be desirable to put in place a longer-term policy approach and remove the need for future temporary extensions”.
That is what the draft regulations seek to achieve.
The Treasury has since conducted a review of the exemption, working closely with UK financial services regulators and with input gathered from industry stakeholders through a call for evidence, which was launched in November 2023. The review found that requiring pension funds to clear derivatives could bring financial stability benefits, such as reducing counterparty risk, and could enhance resilience to shocks by increasing pension funds’ cash buffers. However, it identified concerns from some market participants that removing the exemption could increase pressure on the liquidity management of pension funds, particularly under stressed market conditions, which could increase risks to financial stability.
The review also found strong evidence that pension funds would need to hold more cash and reduce investment in more productive assets if the exemption were removed. That could reduce their returns, with a potential impact on the retirement benefits of future pensioners; it would also be inconsistent with the objectives of the Government’s wider growth reforms, including the pensions investment review, which seeks to unlock new productive investment by pension funds in things like businesses and infrastructure to support economic growth.
Overall, the Government concluded that there was clear evidence that removing the exemption would reduce pension funds’ ability to invest in productive assets, and that that could have an adverse effect on the retirement benefits of future pensioners, while the extent to which removing the exemption would generate direct financial stability benefits was very unclear. The Government have decided that, on balance, it is appropriate to maintain the exemption for the longer term. However, we will keep the policy under review, in co-ordination with the financial services regulators. If there are changes to market dynamics or wider Government reforms that have a material impact on the value of mandatory clearing for pension funds, the Government may reassess the issue.
The draft regulations will implement that policy decision by removing the time limit on the exemption, preventing it from expiring on 18 June this year, as is currently scheduled. They will also remove the Treasury’s power to extend the exemption by two years at a time if it concludes that that is necessary; as the exemption will have no time limit, that power will obviously no longer be required. Firms will not have to do anything differently as a result of the draft regulations, because they will maintain the status quo. This approach provides longer-term clarity and certainty for market participants on the policy position, which will support planning for their long-term investment strategies.
The regulations will maintain this important exemption for the longer term. They will provide certainty for pension funds and will remove the need for the Government to renew the exemption every two years via secondary legislation. They will support pension funds’ ability to generate returns, which fund the retirement benefits of future pensioners, and align with the Government’s objectives to unlock productive investment to support economic growth. I hope that the Committee feels able to support the draft regulations and their objectives; I commend them to the Committee.
Mark Garnier (Wyre Forest) (Con)
Yet again, we are in glorious agreement on both sides of Committee Room 9, which is rather fun. The Opposition absolutely agree with the draft regulations; as the Minister rightly says, the work was started under the last Government, and it is important that we continue to support it. However, we recognise the critical role that central clearing plays in safeguarding financial security.
The Pensions and Lifetime Savings Association, which represents schemes with more than £1.3 trillion in assets, acknowledges that there are benefits: clearing reduces counterparty risk, increases transparency and, in normal times, helps to protect members’ savings. However, the evidence from the sector and, importantly, the experience of the liability-driven investment crisis in 2022 show that mandatory clearing presents a real challenge for pension funds. Most UK schemes do not hold large cash reserves, nor should they: the money should be invested for long-term returns for their pensioners.
The need to raise cash quickly to meet central counterparty margin calls can force schemes to sell assets at precisely the wrong moment, undermining members’ returns and potentially undermining market stability. The LDI crisis in 2022 made things pretty clear; I remind hon. Members that the then Chancellor of the Exchequer and Prime Minister were sacked for creating that chaos. [Interruption.] It’s a fact of life.
In the consultation undertaken by the previous Government, many stakeholders argued that a permanent exemption is the only way to provide certainty and avoid undermining the Government’s own ambitions in the Mansion House reforms. If the exemption were removed, schemes would be forced to hold more liquid, low-return assets, including cash, which would reduce the capital available for long-term investment in the economy. I am therefore delighted to support the draft regulations, but I have a couple of questions.
First, on divergence from the European Union, the UK has opted for an indefinite exemption period, whereas the EU has allowed it to lapse, so clearing is now in place there, as it is in the US. Respondents to the call for evidence highlighted structural differences between the UK and the EU and US markets. Have the Government looked at the effect that that divergence might have on the competitiveness of the UK pension industry and on the relative stability of markets?
My second question is about the long-term intentions as to mandatory clearing. I completely understand that the motivation behind the change is to remove the two-yearly uncertainty. However, the draft regulations provide for a permanent exemption, rather than ruling out clearing in permanency. The difference is a very subtle one, but have the Government considered ruling it out rather than having a permanent exemption? As we are looking at stability for pension funds, I would be interested to hear the Government’s point of view. However, the Opposition certainly do not seek to divide the Committee on this very good policy, which was initiated by the previous Government in one of their more glorious moments.
Daisy Cooper (St Albans) (LD)
The Minister made her case very well. The Liberal Democrats recognise that there is no viable widely adopted method for pension funds to meet the CCP margin requirements without harming pension outcomes. Although we all recognise how important clearing is for broader market stability, we also recognise that enforcing it on pension funds right now could do more harm than good. In that spirit, I add our support to the cross-party agreement on the draft regulations, which will create a permanent exemption.
Emma Reynolds
I thank both hon. Members. As I expected, the shadow Minister agrees with the policy of the previous Government. He asked a couple of questions, and I will take them in the wrong order.
The shadow Minister is right that there is a very slight difference between ruling clearing out completely and making the exemption permanent, but the outcome, which is what we are focusing on, is exactly the same. We have said that we will keep the policy under review if we need to, but overall we think that a permanent exemption gives the industry a lot more certainty than having to roll the exemption over every couple of years. I hope that that gives him some comfort.
In a way, the shadow Minister has answered his own question on divergence from the EU. Our pension systems and the UK defined-benefit market are structurally different from those in other jurisdictions such as the US and the European Union, so we think it entirely appropriate to take a different decision on this issue. The Government are committed to maintaining our high standards of regulation and financial services, including adhering to relevant international standards where appropriate, but we do not think that this will create a divergence that is worrying in any way.
I completely concur with the hon. Member for St Albans that the focus should be on pension outcomes. Maintaining the exemption over time will give certainty to those in the industry, so that they can invest, over the longer term, in assets that will produce returns for their members and therefore pay out the defined-benefit pensions that they are contractually obliged to provide for their members. I hope that I have answered all the Committee’s questions.
Question put and agreed to.